One interesting way of investing in gold is to buy stocks of companies associated with it. Gold stocks are characterized by a high correlation with the price of gold, making them another way of getting exposure to gold without having to own it in physical form. There are two types of gold stocks. Big mining companies that have their own mines, large market capitalization and established market position are called senior mining stocks (seniors). Smaller firms that are still looking for gold, have small market cap (usually below $500 million) and low daily turnover (usually below $700,000) are called junior mining stocks (juniors).
Senior mining stocks
Senior mining stocks are distinguished by high liquidity and lower volatility, therefore they are considered less risky than junior mining stocks. They are usually closely positively correlated with gold. This is because of the fact that stock prices reflect the company’s potential profits and the higher the price of gold, the greater the potential profit.
They also offer leverage, at least in theory. The company’s profit and thus the stock price grow faster than the price of gold. Suppose the gold mining cost is an expense of $700 dollars and current spot price of gold is $900 dollars. The company earns $200 dollars on one ounce. If, however, the price of gold rises to $1000 dollars (11%), the profit rises to $300 dollars (50%). This leverage can also be seen if the price of gold declines. In reality, since 2006 gold mining stocks have risen at a slower pace than the price of gold. It is worth mentioning that gold stocks may decrease much more than the price of gold on world markets. Some firms do however hedge themselves against gold price fluctuations even for a period of up to 18 months. This reduces the influence of short-term gold price fluctuations on the stock price. But it may be the reason why the stock price doesn’t grow even if gold skyrockets.
Senior mining stocks are bought by both individual and institutional investors. They boast relatively lower volatility than juniors and that makes them especially attractive for institutional investors. The fact that institutional investors are interested in seniors makes them a subject of many financial researches, fundamental and technical analysis, mathematical and econometric modeling and valuations. Mistakes of individual investors are very quickly corrected by the market which makes it quite unlikely that one person could change the stock price. Stock price movements really reflect market sentiment and quantitative tools are successful.
Investing in senior mining stocks also involves various risks. There are several types risk: company-specific risk, market risk (systematic risk) and the risk connected with the overall situation on the gold market. A company we invest in may have financial difficulties or even go bankrupt. It can also encounter some mining problems which may translate into higher production costs. If any of the mines is located abroad the currency rate may be another factor influencing its profitability. Currency fluctuations may change mining costs expressed in the currency of the country, where the headquarters are located. All these factors are reflected in the stock price.
Stock prices are also influenced to some extent by the overall situation on the stock market. If the whole market declines, then the probability of senior stock declines increases. Another factor influencing seniors is the price of gold. As mentioned earlier its prices are highly correlated with it, and they rise or fall with gold.
Junior mining stocks
Junior mining stocks are the stocks of companies at the early stage of their development. These are the firms that are still looking for precious metals and are not mining them yet. Even though they do not sell gold or even have any profits they can still be very attractive for investors wanting to invest in gold. They offer leverage and high price volatility.
Junior mining stocks are stocks that institutional investors rarely invest in. They are usually owned by individual investors. This is often because of laws or regulations that prohibit mutual or retirement funds from investing in small companies. It results in lower liquidity for these stocks.
Juniors are considered to be very risky stocks, because they may simply not find the gold or other metals they are looking for. Another drawback is that the majority of their shareholders are individual investors who are susceptible to various emotions. That is why junior mining stocks are highly connected with the emotional state of their owners and general market sentiment. As a result, the stock prices can skyrocket during a bull market. But if there’s a panic in the markets, juniors may drop much more quickly than all other stocks. This may also be the explanation for the high correlation between juniors and major market indices.
Junior and senior mining stocks generally move in the same direction. Sometimes juniors take the lead and grow independently of the most popular gold mining stocks. Other times it may seem that the price of gold does not influence them at all. In the event of a stock selloff their shares may start declining later than the broad market.
Analyzing juniors is much more difficult than analyzing seniors. Buying juniors essentially means buying a promise of mining gold in the future. The company usually doesn’t have any profits yet, there are no positive operating cash flows to be analyzed. So the analysis of juniors should be based on other factors. A good idea may be to analyze properties that belong to the company or to check the management team. Sometimes the test drillings, geological conditions or business environment are also worth analyzing, but this requires a lot of specialist knowledge. One can also go with the analysis made by experts, however in this case there is always the risk that they may not be objective.
Seniors vs. juniors
In some situations seniors may be more attractive, in others juniors are more suitable. It is always best, however, to diversify.
Seniors are undoubtedly safer, they follow gold prices more closely and it is easier to sell them, since they are highly liquid.
Juniors on the other hand are more volatile and less liquid. Generally speaking they are riskier than seniors. In suitable conditions they may rise faster than the stocks of bigger companies. But they also decline more rapidly.
The biggest mining companies in the world
Barrick Gold is the biggest mining company in the world. It is headquartered in Toronto, Canada and has branches in Australia, Africa, North America and South America. In 2010 it had a profit of $3 billion.
Other big mining companies constitute the HUI Index – the most important index of gold mining companies in the world. As of January 12, 2012 it was comprised of the stocks of the following firms:
- Goldcorp Inc.
- Barrick Gold
- Newmont Mining
- Harmony Gold Mining
- Coeur d’alene Mines
- Yamana Gold
- Anglogold Ashanti Ltd.
- Gold Fields Ltd.
- Randgold Resources
- Eldorado Gold Corp.
- Hecla Mining
- Comp de Minas Buenaventura
- New Gold Inc.
- Kinross Gold
- Agnico Eagle Mines