Gold stocks and shares

These do not represent gold at all, but rather are shares in gold mining companies. If the gold price rises, the profits of the gold mining company could be expected to rise and as a result the share price may rise. However, there are many factors to take into account and it is not always the case that the share prices rise when gold rises. Some of the following questions should be asked before investing in the shares of a gold mining company: Has the company already sold its future gold production, through forward sales? Is the company already producing gold, or is it mainly exploring for gold? Does the company make a profit? How many years of ore reserves are left in the mines before they have to be closed down? What PE ratio and dividend yield does the company have now and in the following years? Are the mines subject to political or economic risks?

The basics of investing in gold stocks are relatively straightforward. As a rule, gold stocks trade at greater premiums to underlying value (and earnings) than other resources stocks. The world’s biggest diversified resources stock, BHP Billiton, currently trades on a stock price to earnings (PE) ratio of just under 20 times. Newmont, the world’s biggest gold stock, is almost twice as “expensive”, at 39 times.

As a further rule, gold stocks tend to remain focused on gold; other resources stocks often diversify into any number of metals and commodities. Gold itself is different to the extent that it plays a monetary role in the global financial system. Central banks, and other key financial players, such as the International Monetary Fund, hold significant “above ground” gold hoardings. Buying shares in gold-mining companies avoids the storage problem, but opens up a new can of worms. Gold-mining stocks are two to three times more volatile than gold prices, and no two companies are alike, making them difficult to analyze. "Gold has all kinds of varying grades, meaning grams of gold per ton of rock," says Alan Snyder of Snyder Capital Management in San Francisco. If it costs a company $300 per ounce to get an ounce of gold out of the ground, and the price of gold is less than $300 an ounce, the company makes nothing. If the price goes to $325, the company will start mining, and its profit goes from zero to $25 per ounce. If the price then goes to $350, the company doubles its profit, with almost no increase in cost. This is known as operating leverage, and it varies widely depending on the company's ore deposits. Also, companies must list as reserves any deposits that are profitable to mine at current gold prices. When the price of gold goes up, "a lot of ore that was too costly to mine at yesterday's price and therefore was not counted in reserves is now profitable and is counted in reserves," Snyder says. Investors value gold stocks based on their price relative to reserves. When reserves go up, stock prices tend to follow -- and vice versa. Another variable is whether the company has hedged or "sold forward," meaning it has sold future production at current prices. Last year, when gold prices were soaring, shares in Barrick Gold -- a large, stable company -- actually dropped because it had hedged a lot of its production. "The perception was, if gold goes up, Barrick won't benefit," says Lynn Russell, a gold-fund analyst at Morningstar. Most large companies have cut way back on hedging. Investors should never buy just one mining company, because most of them work in parts of the world subject to political upheaval, earthquakes and other natural and man-made disasters.