Six tips for buying shares in gold companies

The following is my latest contribution to the Australian Financial Review. Click here to read the article on their site. 

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Gold has been a store of value that has lasted an age. Prized for its beauty and non-corrosive elements, gold is an investment that, despite price volatility, is often viewed as a defensive investment.

In the current environment where fears of macro economic implosions, geopolitical melt-downs and asset bubbles, many investors have sought the safety of glittering gold.

Beyond buying physical gold and storing it at the Perth Mint, or holding the GOLD ETF, many investors have added gold stocks into their portfolio as a hedge against possible catastrophe.

One key mistake that many investors make when investing in gold stocks is believing that they are buying into the same properties as the physical commodity itself. It is true that in the short-term, share price will be governed by the change in the price of the gold. However, over the long term, investors must realise that what they are actually investing is a physical business. One that generates sales, pays expenses, makes profits and ultimately is at risk to many of the same factors which can affect any business you invest in.

So what should you look for when investing in a gold or any mining business? The complete answer to this question is multifaceted, but here are basic principles to determine whether your gold stock is the quality business.

Fundamentals – given the very cyclical nature of the gold price, unless the company is sound fundamentally, particularly from a cash flow perspective, then it is at risk of not only failing but also needing to perform on-going capital raisings which could dilute the interests of existing shareholders. Gold explorers who are not yet producing or cashflow positive do not exhibit the safety properties investors may be seeking..

Resource size - Knowing the amount of gold a company sits on is something investors should be aware of, including the estimated mine life. Without it you really don’t have a mining business. As an added focus, look for reserve upgrades so that resources can be replenished, because once the commodity comes out of the ground, it’s gone. Therefore, reserve upgrades from existing sites or new projects is important for a gold miner’s long term viability.

Good production profile - When it comes to commodity businesses, one outcome that they can control is the amount they produce over a period. For all mining stocks this is monitored quarterly and investors can see the fruits of the company’s labour through announcements made on the ASX. Ideally the company has an increasing production (ramp up) profile, the more it can absorb short term commodity price volatility.

Cost management – In the same way the level of production can be controlled to a degree, so to the cost of extracting the resource. The all in sustaining costs (AISC) of a mining business is also often declared every quarter. Investors can see whether the cost of actually getting the gold out of the ground is being done efficiently and sustainably. The higher the cost to extract the mineral, the more susceptible the business is to commodity price movements.

Currency moves - Gold is sold in $USD. Therefore, for Australian producers who sell in USD but incur expenses in AUD, a weak Aussie dollar is good for profitability.

The other currency to consider is if the $USD rises, historically the gold price falls and vice versa. Many consider this correlation more important to the direction of gold prices than the fears which see investors attracted to gold in the first place.

The price of Gold - Neither the miners or investors can control the price of any commodity, rather they simply need to adapt. There are times that the gold price can fall to levels where many mines become unprofitable. And vice-versa, the price of gold can jump so much that even the less quality high producers are making money.

An understanding of the key fundamental drivers of a Gold miner is necessary to determine first and foremost that it is indeed a quality business. This will ensure you identify a sound business to invest in, because volatility in commodity prices is a fact of life, and investors need comfort that the underlying business can withstand shifts when they occur.

Australian Gold Producers with a StockRank above 80 & >$500M Mkt Cap for consideration

Data as at 12 October 2023

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