Gold & Silver Company Investing (Pt 1)

Gold & Silver Miners, Gold and Silver Streamers, & Leveraged Gold ETF’s are three ways to potentially achieve greater appreciation than the movement on the price of gold (or silver) itself.  In this & the following posts, we’ll discuss each of these.  We’ve been discussing asset management in a crazy economy.  We’re using the broad category of Derivatives so that we can put all these together, but the only one which is truly a derivative in the financial sense is the Leveraged ETF.  The others are companies which bring these precious metals to market and as an owner of these companies you are able experience the profit or loss of the company.

If you’ve been reading this blog for some time, you should already clearly understand that physical gold & silver in your possession (not owned on paper) is the most important first step of gold and silver ownership.  You should own them there first before you even consider investing in shares.  The following is based upon the understanding that you already own these.  We also spoke in that section of owning gold and silver in paper form which can also be wise.  This section looks to invest in ways which hopefully achieve leverage to the price action in the metals.

Gold & Silver Mining Companies

If you believe that the price of gold &/or silver is going to increase in the coming years, then you should consider owning shares of miners.  Typically, the share price of miners move up or down in multiples of the price movement of gold or silver.  Or course; there is nothing scientific about this.  Depending on the mood of the markets, the miners might move more or less dramatically at any given time than the price of the metal itself.  But as a general concept, the idea of investing here is that the price will move at a multiple of the underlying metal.

Think about it, a gold (or silver) mine is a simple operation.  It owns a bunch of gold (or silver) in the ground.  Its business is digging it up.  There are costs for digging this metal out of the ground that are relatively fixed.  If the mine owns millions of ounces of gold in the ground and the price of gold doubles, their costs stay fixed, but their revenue doubles.  This means that the profits of the company would more than double.  Let’s give an example.  Let’s say a company has these numbers…

Annual Production          1,000,000 ounces

Cost per Ounce                 $500

Cost of Gold                       $1,000

Yearly Profit                       $500,000,000

Now what happens if the price of gold doubles? That profit quickly triples to $1.5B.  Because the costs stayed the same, the higher gold price went straight to the bottom line.  This is why gold bugs get so excited about investing in gold mines.  They own tremendous numbers of ounces of gold in the ground!  Actually, some miners don’t even bother to mine the gold or silver, they simply find the gold and sit on it and allow their price to go up or down purely based on the fact that they own this underground treasure chest.

So we generally believe that the price of gold & silver miner shares will increase dramatically in the coming years as the price of gold & silver increases.

However, there are some risks to investing in miners that isn’t present in owning the metals themselves. One of the biggest expenses a miner has is the cost of the oil needed to run all the mining equipment.  If the price of oil shoots up dramatically (which we also expect), this cuts into the profits of the company.

Sometimes the price of gold and silver miners go down with the stock market even though the price of gold and silver is going up!  This can be very frustrating as an owner, but remember, the stock market is an emotional beast.  When the market is falling, people will sell all sorts of things just to get out of the market.  So even though the price of the metal which leads to profits for the miner might be going up, if the stock market itself is going down and investors are panicking, the price of these miners can go down right along with the overall market (although this is not always the case).

Another consideration is that governments around the world are constantly trying to get their hands on new sources of revenue and miners are seen as an easy target.  (Think of the way the movie Avatar vilified miners.)  This is a constant source of danger with all the many governments around the world.  Of course, this has always been the case and miners have been spectacular investments at certain times in history.

Next we’ll look at the different ways to invest in specific gold and silver mining companies and streamers.  If you have any thoughts or questions on this or other topics, please let us know.

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