Gold Mining Shares Are Speculative and Gold Bullion Is A Better Investment

– Gold mining shares require timing and are speculative

– Gold mining: “maximising risk, while minimising reward”

– Gold mining is increasingly complicated, difficult & much riskier

– Easier, more cost efficient and safer to buy physical gold than mining stocks

– “If your strategy is buy and hold, or buy and forget, go for the metal, not the miners”

– Owning allocated and segregated gold is a hedge against digital and systemic risks

Gold price in USD in gold and gold mining shares (HUI) in dark blue (Money Week)

by Dominic Frisby in  Money Week

Today I want to look at gold and the large gold miners.

I’ll consider the relative performance of the two and ask: which is the better investment?

Gold miners: maximising risk, while minimising reward

As my measure of gold miners, I am going to use the HUI (or, to give it its full title, the NYSE Arca Gold BUGS index). BUGS stands for “basket of unhedged gold stocks”, meaning these companies do not hedge.

What does “hedge” mean? Some companies will sell their gold before they have actually mined it in order to guarantee a certain price. This practice – hedging – reduces risk. They know they will get this price for their metal.

But hedging can be disastrous in a bull market: you lock in a certain price, the gold price goes up, and you are forced to sell your gold at the lower price. You lose the benefits of the bull market.

After the bear markets of the 1980s and 90s, many miners carried this practice of hedging over into the 2000s and were made to look like fools, as they were selling their gold at $350 and $400 an ounce, when gold was $750 or $800.

However, I stress that hedging can be a saviour in a bear market. You sell your gold at $500 and it falls to $250 – you’re a genius.

Anyway, for the purposes of drawing a comparison between gold and the gold miners, we will look only at those large mining companies that do not hedge. Their index is the HUI. (I stress I am talking about large mining companies, not junior explorers and so on.)

 

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This first chart shows the relative performance of the two since 2000 overlaid. Gold is in gold and the miners are in dark blue.

You can see that over the last 18 years gold has gone from below $300 an ounce to $1,350, or thereabouts, yesterday. The HUI has gone from just below $75 to $182. So the HUI is up around 150%, while gold is up around 350%.

In terms of relative performance, in short, gold has annihilated the miners.

Miners are supposed to provide leverage to the gold price. That is why one speculates in them. If gold rises, say, 20% or 30%, you should be looking at at least a 50% gain in the mining company.

After all, you are taking on the additional risk of buying a mining company – the risk of the competence of the management, the political risk, the operational risk – and the compensation for that risk is the reward of greater gains.

Except that palpably has not happened. You would have been far better off just buying the metal. Far less risk; far greater gain.

Management of mining companies have to take a lot of responsibility for this. They haven’t run their companies well. Incompetence is a sector-wide affliction. Bad