Fools Gold: Five Common Mistakes with Gold Investments

You want to own gold. Maybe you’re worried about the potentially detrimental inflationary effects emanating from the Fed’s and global central banks’ policies; maybe you’re worried that the fiscal cliff agreement is simply kicking the can down the road and fiscal Armageddon looms on the horizon. Whether you’re in search of inflation protection, a safe haven asset, or both, gold may be a part of the  solution.

Regardless of your reasoning, owning the ultimate currency is not as  straightforward as you might think. To help out, we’ve compiled five common mistakes associated with investments in the precious metal. Avoiding the common pitfalls may help provide you with the desired investment exposure while minimizing any unanticipated drawbacks. Ultimately, we hope the following list can help reduce investment
headaches associated with your future gold investments.
 

1. Gold Stocks Ain’t Gold

A frequent mistake made by investors is to invest in gold mining  companies (both juniors and majors) as a substitute for gold. There are a couple of reasons why this may be a mistake. Firstly, gold mining company’s stock price does not precisely track the price of gold.

That’s because lots of other factors influence the share price of a company: management, cost pressures, mining diversification, stage of the mining process, to  name just a few. This problem is generally more acute for juniors than majors, because juniors often have yet to “strike gold,” therefore the stock price often trades more like an option. Moreover, many mining companies don’t only mine gold, many also mine silver, palladium, diamonds etc. This dynamic also holds for baskets of mining companies – baskets of miners have significantly underperformed the price of gold over recent years.

Some investors believe gold mining stocks may provide more attractive investment exposure to gold than gold itself. The investment thesis is as follows: gold mining companies are able to take advantage of an increase in the price of gold through enhanced operational leverage; as the gold price goes up, mining  companies’ margins widen, ultimately  increasing the bottom line. However, this theory is predicated on fixed costs staying relatively constant. Unfortunately, recent performance does not support this investment idea. Indeed, gold mining stocks, on aggregate, have significantly underperformed the price of gold. The reality is that  mining is a highly energy- intensive undertaking, and therefore many of the costs are closely linked to energy prices, such as oil, which has  also experienced significant increases in price. As a result, many  mining companies have not produced the anticipated high level of  profits. Additionally, governments may demand higher taxes and  employees higher wages from mining companies should profitability  increase, further limiting the upside potential for shareholders.


 

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