How to Invest in Gold Stocks
Although I have been investing in the stock market since the 1990’s, starting in 2002 I have been an investor in gold bullion and a trader in gold stocks. At the beginning of 2002 I came to the conclusion that gold and commodities were about to begin a new secular bull market that would last well over ten years. Since that moment I have bought and recommended many gold, silver, and energy stocks and my subscribers and I have benefited from the bull market in commodities.
The simplest and safest way to invest in gold is to simply by gold bullion from a reputable precious metals dealer like Regal Assets. Whether you buy coins or bars is up to you. Most people like a mix of both. I consider my bullion holdings as the safest part of my overall investment portfolio - I consider it my real Fort Knox.
You see I consider my investments outside of gold bullion to be more speculative in a nature. Stocks as a whole tend to be more volatile than gold bullion and can individually be impacted in both positive and negative ways to specific company news. It is not unusual to see gold prices go up and then shares of an individual gold company go down, because it had to announce bad news, may it be a negative earnings release or a need to do a secondary offering to raise money by selling more stock, thereby diluting current shareholders.
However, the right gold stocks will rise exponentially as the gold bull market continue. Higher risks means the potential for higher rewards.
Investing in Gold Companies
One good and bad thing about buying gold stocks and exchange traded funds that invest in gold is that you have instant liquidity - if you want to take your investment out all you have to do is call your stock broker and get out at the quoted market price. If you trade online you don't even have to do that - you can just turn on your computer, connect to the Internet and type!
With gold bullion and coins you have to find a gold dealer or another individual who is willing to purchase your gold. It's an extra step. If you decide to sell your gold then you have to package your physical gold up and mail it to a dealer or else get in your car and take it to someone.
This can actually be a good thing. Most people who try to trade in and out of gold actually make mistakes. If things go up for a few months they get tempted to sell and then end up left behind when the market goes up without them or else they worry during little corrections and sell on bottoms. So having a nice core Fort Knox position in gold bullion that isn't as easy to sell as pressing a button is good, because it means you'll be less likely to make the mistake of selling out too soon. You'll learn not to worry about it and to just enjoy holding on to it. Most people who own stocks look at the trading quotes all of the time, get stressed out over little gyrations, and make mistakes.
That said though the right gold stocks have the potential to go up even more than the price of gold does over the next few years. You see the profits that mining companies generate during a gold bull market are tremendous, because when the price of gold moves up their profits explode exponentially. For example if the price of gold rises from $280 to $308 an ounce that represents a 10% increase. To show you what this means if it costs a gold company on average $180 to get an ounce of gold out of the ground then a 10% move in the price of gold from $280 to $308 translates into a 28% increase in profits for the gold company.
This gives a gold investor tremendous leverage for his investment dollars and gold stocks tend to rise by a much larger percentage than the price of gold itself during a gold bull market. In fact the gains can be astronomical and it is that fact that first brought my interest to the gold market. That should be no surprise because when the profits of a company increase rapidly stocks almost always follow.
Mining stocks then are essentially leveraged investments in gold. That is why they can go up more than gold does at times and can also crash to nothing too. After the last secular bull market in gold came to an end in 1980 most gold stocks actually went to zero - the companies went bankrupt! After that a few dozen of the biggest companies came to dominate the industry for the next few decades.
The Gold Industry
Now back in 2002 when I realized that the opportunities to profit in the gold bull market were going to become a once in a lifetime opportunity that I had to take advantage I didn't know anything about gold! I knew a lot about stocks and financial markets, but gold was a whole world on to itself.
So I realized that I needed to make contacts with gold analysts, newsletter writers, and management teams. I wanted to know what makes the gold community tick so that I could build off of their advice and get access to the private market place. I was determined to make money in gold and decided that I needed to meet and befriend some real gold experts that could bring me up to speed.
So I started to travel to mining industry shows across the United State and Canada. Most of them were organized in the same fashion. They rented out a conference center and divided it up in two sections. In the first section there are speaker panels and smaller workshops where you can get one on one attention and in the second section there is almost always an exhibition hall with booths.
These booths were made up of brokers, companies making trading software, and small cap companies trying to attract investor interest. Despite the dozen or so major gold conferences a year, in reality the gold community is small.
When I first started attending these conferences, very little money was actually flowing into gold companies, even though the stocks were going higher. The simple fact of the matter is that gold and the gold stocks are only a small segment of the financial world. At the start of 2001 the combined market cap for all publicly traded gold stocks was less than the market cap of Disney. As I write this Wall Street is still shunning them. Mainstream investors and CNBC talking heads have not accepted the fact that gold is in a bull market. They still think that the gold rally will fail and are afraid to commit money to it. This is why the small gold companies still use private investors for financing and depend on newsletters and investment conferences for exposure.
On one hand this is a good thing. You can make contacts with the leaders of the gold industry yourself and most gold companies are very compliant with individual investors. This is a virtual impossibility right now in sectors such as technology. You would have a difficult time trying to meet Bill Gates or Larry Ellison at an investment conference, but you can meet Robert McEwen, who helped to build GoldCorp into a company with a market cap of over $29 billion at a gold conference.
On the other hand, many tiny gold companies are nothing but pieces of paper and their reliance on small newsletter writers for exposure is a sign of their lack of investment merit. In fact many of them border on being outright frauds. When I started to go to investment conferences that featured gold companies, I made it a point to have private conversations with the gold CEO's to get a better feel for the industry. I spent one night with one of them on a $3 1/2 million dollar yacht watching football and drinking beer. Loose lips are more revealing.
I have never had a position in this man's company and don't now. I took a liking to this guy and he seemed straight to me. Of course he believed that gold will go up, but warned me that 80% of the small cap exploration companies are “fake.” He has a 25-year background in the industry and knows most of the key players. The analysts don't follow the stocks so all you have are newsletter writers. I asked him who can the small investors rely on? He laughed and said that most of them are bought off with stock. He told me of one or two that were good, but then added, "you need to understand that they need to make a living."
He went on to tell me that when it comes to exploration companies it is all about promotion. His words made comments that I heard from another CEO of a small exploration company earlier that day bounce in my head. During that conversation with this dude he made a side remark to the effect that gold exploration companies are the best companies to run, because the balance sheet doesn't matter. Earnings don't matter. He said that people don't know how to value your properties and it is all about its unknown potential and the ”psychology” of gold.
The last time I heard CEO's say that their earnings didn't matter was during the Internet mania. Those stocks flew and crashed to nothing. When the gold bull is over most of the small cap gold stocks will go back to nothing too. However, before then you will eventually see bunches of new companies appear out of nowhere and have their moment in the sun.
I got the impression from both men that stock promotion is central to the junior mining and gold exploration stocks. The man on the yacht point blank told me that it is not the shares of companies with good resources that go up the most, but the ones with the heaviest promotion that does. The way he put it if you have good properties and no promotion the stock will lag, but if you have crap properties and heavy promotion it will fly as gold goes higher. And if you have both then you have a rocket.
The easiest way for people to promote a gold stock is to get newsletter writers involved, especially those that specialize in the gold market. They are the people who can directly reach potential investors. Promoters get them involved by allowing them to buy stock at steep discounts on the private market, paying them money, or by simply giving them shares.
One of the most popular ways to promote a stock is to send out mass mail flyers to investors. These fliers almost always will feature a newsletter writer, who supposedly has earned his subscribers unbelievable profits, and a write up for the company that it should go up 1000% or even more. That write up is the real purpose of the mailing. The newsletter writer is just there to give it credibility.
The problem is that more often than not the investor who buys on these mailings is buying in near a top. The promoter, the newsletter writer, and everyone else involved in pumping the stock already got in way before the flier is sent out. After the last sucker gets in the stock almost always goes back down. You see with no earnings or real prospects they have nowhere else to go. It's like the movie Boiler Room.
For the record I do not engage in any of these promotional activities. I am not paid to promote stocks. In the gold industry, it is rare to find a newsletter writer who isn’t involved in this sort of activity. I’ve even heard of one writer calling the gold companies himself and asking them how much they will pay him to write up their stock! Luckily there are ways that you can determine whether or not a newsletter writer is doing real analysis or is just giving you a sales pitch. And there are indeed a few top-notch analysts out there.
There is a simple way to separate the wheat from the chaff. Anyone who recommends a stock must put a disclosure with their recommendation if they already own shares or were given stock or paid cash by the company or a third-party. Read the writer’s disclaimer very carefully to see this disclosure. If they simply own shares that they bought that is one thing, but if they are being compensated to promote the stock be very wary of what you are reading, because it is not an unbiased piece of research.
As time goes on I expect these conflicts of interest to become a big issue. Investor awareness will increase. I just hope that it won’t take a scandal for it to start. For now you must carefully choose which newsletters that you follow and make sure they are being written by real independent analysts and aren’t just tout sheets.
I learned from talking to these CEO’s that I needed to be careful in what I invest in. I needed to learn for myself what is the best way to evaluate a gold company. I put lots of my own money into work in the market and I want to buy the best stocks, not just ones that are going up because everything else is, or because they are being promoted. If you are going to buy into a basket of gold stocks you should just buy the best ones.
Types of Gold Stocks
The trick is how to determine which gold stocks have real potential. The safest gold stocks are the large producing gold companies. Every collection of gold stocks should revolve around a core holding in a few of the largest producers. These companies include Anglogold, Barrick Gold, and Newmont Mining among others. They are the stocks that are the institutional favorites of mutual fund managers. In fact if the gold bull market continues the way that I expect it will then Newmont will become a must own stock, much like Cisco Systems was in the 1990’s.
Generally speaking the higher the potential gain the higher the risk that an investor takes in a stock. Higher returns are available to gold investors from mid-tier producing gold companies that mine anywhere from 100,000 to 1,000,000 ounces of gold a year. These stocks have smaller share floats so it takes less money flowing into the stock to make it go up in value. The companies have at least one producing mine and often own several mines, some of which may have higher production costs and were closed during the last gold bear market. As the price of gold advances these mines reopen, to provide a boost to the company’s profits. A lot of these companies end up getting bought out. Bema Gold, Wheaton River, and Cambior were all mid-tier producers who got bought out at huge prices.
Mid-tier mining companies can become takeover targets and often engage in gold exploration activities. Often they join smaller exploration companies in developing potential mines. Mid-tier mining companies are very dependent on the price of gold and often take on debt to develop mining properties. As a result if the gold price drops they often have to scramble to raise more capital, which means diluting shareholders or floating more debt, and some of them often become insolvent during gold bear markets.
Below the large and mid-tier producers are exploration and junior mining companies, which make up most of the gold companies on the exchanges. Exploration companies consist of only a couple of employees, most of whom are geologists, who search for new gold deposits in hopes of finding the next big discovery. They raise money to purchase claims on properties. Their shares are penny stocks and are akin to lottery tickets. Only one in a thousand pay off in the end. Of course the reward when one of these companies hits pay dirt is enormous, but for every one of these stocks that become big winners hundreds become zeros.
Junior mining companies try to transform exploration properties into producing mines. Some junior mining companies have mines in production, but most of them are only a step above exploration companies. Those that do have mines usually have ones of a lower quality and need to open new ones to replace them when they run out of ore. However, when a new mine comes on line earnings for these companies go through the roof. Both the exploration and junior mining sectors are riddled with stock promoters and are high-risk speculations. There is a reason why penny stocks are worth only pennies. The difference between investing in a bar of bullion and investing in a penny stock is miles apart. There are no penny stocks in Fort Knox.
Choosing Gold Companies as Investments
When it comes to gold stocks I invest in a core position of large producers through a gold mining stock ETF, such as GDX or GDXJ, which owns a swath of gold producers. Then I usually build the rest of my gold stock portfolio around a basket of individual stocks in large and mid-tier producers or emerging producers. I believe they give me a good risk to reward ratio for each dollar I spend, as many of the shares of mid-tier companies double during rallies in the gold bull market. Most of them also trade over 1,000,000 shares a day. That is enough volume to allow me to build substantial positions and prevent any liquidity problems.
I look for mid-tier companies whose gold production is slated to increase over the next few years, enabling their earnings to grow exponentially even if the price of gold does not rise. They may be planning on reopening mines that have been out of production or have purchased mines from junior gold companies.
In special cases I do invest in junior and exploration companies, but only after a full study of their projects. Most of these companies eventually either get bought out or go out of business. When you become one of their stockholders you become a shareholder and partner in their venture. You are making a bet not only that management can succeed, but that they are on your side and are interested in enhancing shareholder value by building a successful operation and aren’t just trying to pad their pockets through stock jobbing. You need to know who the people are behind the company and understand their business model. Do they have properties worth exploring and developing and will they have the resources to execute?
There are simple questions that you can ask. Whose money is already in the company? How much of the company’s financing came from insiders and the management team and how much of it came from brokerage houses and individual investors? Is the management team paying itself in large salaries or do they expect to make money from gains in the share price along with their investors? If they are making stock transactions are they buying or selling shares?
What is the background of the management team? Have they built successful companies before? If they made mistakes in the past were they fooled themselves or did they fool their stockholders? Have the geologists involved in the company made successful discoveries in the past? What type of experience does the chief engineer have?
If you ask these simple questions then you’ll invest your money with the top people in the industry. The other thing you need to know is how exploration and junior mining companies develop. This will help you evaluate whether or not an exploration company has a viable property or not and if a junior mining company is going to be able to develop a mine.
How Mining Companies Are Developed
Exploration is the first stage of development. Many exploration companies go to hot areas of the market where gold has already been discovered and mined. At some point in a gold bull market area plays develop and exploration companies appear out of nowhere to play off someone else’s success. You need to be wary of a company whose only selling point is the area that it is in.
An exploration team will have its engineers survey its properties. Once they determine that there is likely a solid gold deposit, they will need to raise money in order to prove it. The company then drills holes on the property far apart from each other to get an idea of where the gold may be concentrated.
If the first drill results are successful, the company will carry out another drill test, called an “infill drilling” test. This test consists of drilling new holes in between the first ones in order to get a rough idea of the deposit size and ore grade. The drill results are then taken and the gold deposit is classified. You need to understand the classification system so that you can understand how viable the project is.
A deposit classified as a geological resource is the lowest grade deposit. Gold or silver has been found and a rough estimate has been made to its size and grade based on limited evidence. Further evaluation is needed. This classification is also called inferred, estimated, or drill-indicated. This level of resources has the lowest chance of ever being mined and it is best to stay away from exploration companies that tout such properties.
Most deposits are classified as a possible, probable, or proven reserve. Proven reserves have the highest confidence level and were measured with 50 feet drilling spacing. Probable reserves often used 100 feet drill spacing, while possible reserves uses even wider drill spacing.
The SEC does not allow companies to include possible reserves when they total their ore reserves. Canada accepts them and allows mining companies to include them with their proven and possible reserves in press releases and shareholder reports. In reality they are very low-grade properties and should not be counted as strong assets on a company’s balance sheet. Be wary of Canadian mining companies whose portfolio is made up of possible reserves.
If the exploration company’s survey of a property is promising then it will go the next step, which is a feasibility study. This study further examines and defines the ore reserve and its size, identifies mining methods, estimates capital costs, and projects profitability and return on investment. A feasibility study can take up to three years to complete and once it is finished costs are calculated within a 15% margin. The process of going from exploration to a feasibility survey is what turns exploration companies into junior mining companies.
The next stage of development is the construction of the mine. This can cost a hundred million dollars, which is way more money than junior exploration companies have. If they can’t finance the operation themselves then they will try to attract a larger partner to assist in the project or buy them out. If gold is in a bear trend than the project will sit idle until a new bull market in gold begins, a fact that causes many idle projects to sit in waiting.
The costs and time it takes to get the mine in operation can vary widely. A lot depends on the location of the property and the country that it is in. Stringent environmental laws and bureaucracy can drag out the process and raise costs. Once construction begins and the mine is operation more knowledge about the size and grade of the ore is obtained.
Even though a company that goes from exploration to production can be a bonanza for shareholders, it won’t necessarily last. All mines run out of ore eventually and the company will have to one-day find new gold reserves, if not at the current mine then at another property. If it doesn’t then it will likely go bankrupt.
In the end exploration and junior resource stocks can make profitable speculations, but they are almost all poor long-term investments. That's why in the long-run gold bullion acts as a better core investment position than a pile of penny stocks. Gold bullion is your Fort Knox.
I will Help You
When I started to talk with you about gold I had one objective in mind - to help you as much as possible benefit from this gold bull market. I hope you will make purchases in gold bullion and consider that the core Fort Knox position of your portfolio - that part of your portfolio that serves as a ballast of protection and profit in this financial environment.
Outside of gold bullion I also have a stock brokerage account where I invest in and trade individual funds and individual stocks. If you don't have a broker and are wondering which is a good one to use than you might want to check out Etrade or Scottrade. Scottrade has physical offices spread out all over the United States and often holds small investment seminars to help people if you feel more comfortable dealing with someone in person than strictly only over the Internet. If you are in Canada you might want to try out TD Waterhouse. I've had people tell me good things about them too.
Now going forward I will help you by showing you what I own and when I buy and sell positions.
I cannot think of any better to help you than that. You can see what I own right now by going to my trading blog at WallStreetWindow.com and then clicking on the top nav bar on that site where it says Open Portfolio. You'll find a spreadsheet file right there with my current positions.
No one on CNBC will show you anything like that. I'm doing this because now is the time and I figure that the more I actually help people the more goodwill I'll get back too. You see the more you help people the more your reputation will spread. If you like what you get from me you'll tell others about it and spread the word too. Then I'll benefit when people buy a membership to this site. Gold is not going up because the media is telling people to buy it, it is going because of word of mouth. The gold community is a true group of believers that helps one another. When new people join we all win.
If you want to start to invest in gold bullion by buying a few buys then contact Regal Assets. Just fill out the form below. Request your free gold kit and give them your mailing address and phone number so they can call and verify it. Now is the time to get into gold.
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