When looking to invest in gold, you can invest in physical gold, or you can invest in gold producers, a.k.a mining companies. While both have been flat at best so far this year, it is interesting to note that gold mining companies have underperformed the price of gold for the last year or so.
As such, plenty of investors have been saying that this a great time to invest - that is, if the bull market in gold still has more to it over the next few years. Unfortunately, there are a lot of other variables, and there might be a good short term reason gold miners haven't been outpacing gold.
Investing in Gold
The most obvious way to get gold exposure is to just buy the physical stuff. That's what I do for my "insurance stash" of gold. There are more easy methods of buying gold, of course, like GLD or some other ETF, or by opening an account at BullionVault.com or some other gold storage/trading service. Most of the article below works for comparing silver stocks to SLV or another silver bullion investment.
But the problem with buying gold is that it's connected only to the demand of gold. For some people, it's simply not enough upside (even though it's had a heck of a run so far for the last 10-12 years). Those individuals often start looking into gold mining companies. I've written about gold mining stocks in the past, covering the pros and cons, but I'll be focusing on an important angle for this article.
Investing in Gold Mining Companies
These gold mining stocks do not directly match the price of gold. Since most companies sell their gold through future contracts, they may not realize today's spot price for several months. As such, their revenues typically lag the spot price.
As such, historically when gold mining companies have lagged the price of gold, they usually have a period following of outperformance compared to the price of gold. Since that has been the case for the first quarter of the year, gold mining companies could potentially be a good investment going forward -- if they actually "catch up," that is.
And that's the problem. Almost every day for two years, many gold-bug newsletters I'm subscribed to have been pitching the notion that gold miners are about to explode because they haven't been keeping up with gold bullion prices. The most intense these bullish pitches got was in the summer of 2011. Unfortunately, it seems like most of the writers seemed to have forgotten the most obvious reason gold mining stocks might have been so "cheap" -- gold bullion was simply reacting to reflexivity that summer, and was going straight up too fast and was about to take a heavy hit.
Turns out that was the case, at least for the short price run up during the summer. Gold has been so flat in the last 6-8 months, that I'm sure plenty of speculators have had some kind of cabin fever. And since investing in gold mining companies is actually investing in a company, there is usually more upside potential and less downside potential compared to investing in physical gold.
Miners Haven't Kept Up With Bullion
So do gold mining companies keep up with gold bullion? It depends on how you calculate it. Chances are, at least over the last few years, gold miners simply haven't kept up with gold. For example, GDM and GDX have both trailed gold by nearly a 100% over the last 5 years. That's not looking good. And there are others that are flat. There are, of course, penny stocks and medium miners that have done great, but most averages are level or down compared to bullion.
There are several reasons miners haven't picked up the slack compared to bullion:
Stocks have extra risk. They can go bankrupt. They can be nationalized. They can miscalculate their gold. They can have accidents. They can whatever. There are literally thousands of new variables that could destroy the companies in particular, much less slow down profits.
Long-term bull isn't certain. Not everyone is betting on gold for the long-term -- there are a lot of short-term speculators. That's why gold spiked so heavily in 2011, and gold mining stocks didn't spike nearly as much -- not even close. This lack of long-term certainty is priced into miners to some extent.
Extreme long-term uncertainty. Some mining stocks in the ETFs simply don't have enough known gold in the dirt to last an incredibly long-amount of time. This is a risk. It's getting harder to mine gold, and it's not nearly as easy as it once was. Gold's price increasing can help, but it's still a downward pressure on miners compared to gold bullion itself.
What About Right Now?
There's a chance that gold will drop whenever interest rates are lowered by the Fed and the market is convinced (rightly or wrongly) of an imminent recovery. But when -- or if -- this happens is anybody's guess. Billionaire Jim Rogers believes we'll see some strong bubble-like economic recovery over the next year or two, so there's a chance the price of gold could dip in the meantime.
Still, right now, the US federal government has no real exit strategy for the insane deficits that we're creating - except for money-printing that is. And that means that gold prices are still a great long-term bet. Unless some sort of anti-deficit movement takes hold in the next five years, look for gold corrections as a time to buy into gold for the very long haul. Just don't bet the farm - a well-diversified portfolio is always better than a huge lopsided bet.
That's one of many reasons I'm still adding to my position in gold -- but in physical bullion, and not miners. Unless something crazy happens and a good deal is revealed, I'll likely keep this position and tactic for the foreseeable future.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I do own physical gold and silver and will likely be adding to my position every month for the foreseeable future.
