Investing in bullion vs. mining stocks

Share prices for precious metals mining companies finally started responding to higher metal prices.

The XAU -- a popular index fund containing publicly traded companies mining for both gold and silver -- began a run higher 18 months ago after going nowhere for the decade before.

Today, investors are wondering whether they should be buying mining shares. The answer is maybe -- if you know what you are doing.

For investors, the conventional wisdom is that mining shares offer a leveraged bet on the prices of gold and silver. If gold and silver prices are rising, the companies producing them will outperform the metals.

The conventional wisdom certainly makes intuitive sense, but successful investing in mining companies is a lot more complicated than an investment in physical bullion.

An investor can’t just randomly purchase the shares of any gold miner and expect to win big if the price of gold rises.

The share price of Barrick Gold, one of the largest gold mining companies in the world, closed at $36.25 on Friday. Relative to the share price of around $21 just 6 months ago, that isn’t too shabby. But those shares traded above $40 in the mid ‘90s and closer to $50 in 2010-2011.

People who have owned Barrick stock for the past 30 years can attest to the reality that higher metal prices do not necessarily improve a mining company’s bottom line.

Mining shares can outperform the metal, but only under certain conditions. The company has to dodge big mistakes, avoid government money grabs and local community extortion, manage costs, avoid nasty surprises, and put shareholders first.

And, a mining company must, of course, find and mine good-quality deposits.

Make no mistake… mining is an extraordinarily difficult business.

This is visible in the production numbers. Global gold mine output peaked in 2018 and has been largely stagnant since, despite the run higher in gold prices. Output for silver is declining.

Difficulty isn’t the only challenge in the precious metals mining industry. There is also a problem with hype, which investors should understand.

Mark Twain once said, “A gold mine is a hole in the ground with a liar standing beside it.” That is obvious hyperbole, but the sentiment cannot be dismissed.

The mining space is littered with failed projects which put a torch to mountains of capital. Investors found out the hard way that the story they bought was way better than the reality.

One way to diversify and minimize the risk of picking individual stocks is to buy an index fund instead.

The trouble is the indexes aren’t outperforming the metal. In fact, they are a little behind.

Since Jan. 1, 2000, the gold price has risen 12.4 times. The HUI -- a popular index fund focused on gold mining companies – is up 11.8 times.

The conventional wisdom about mining shares outperforming the metal isn’t exactly wrong, but it certainly doesn’t contain any of the nuance an investor needs. Based on performance in recent decades, one can’t just buy the index and expect to beat the metal.

To have the best shot of outperforming, investors probably need to pick individual stocks – or invest in the royalty and streaming companies in the sector.

All in all, investing in mining is a very tricky proposition. Most will likely be happier just buying the metal.

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