The Dangers of Buying Gold Mining Stocks

Stock MarketThere are some investors who just don’t want the hassle of buying and storing physical gold, so they turn to easier gold investments like gold ETFs or gold mining stocks. While this makes sense, it never really works out quite as well as owning physical gold that you have in your possession and that you know already exists. With ETFs, there is a piece of paper supposedly promising you some gold somewhere. With gold miners, you would think you also have some claim to the gold in the ground, but that is also not necessarily the case. Let’s take a look at three areas that can uniquely impact the price of gold mining stocks more than a physical bar of gold.

Gold Prices

The price of gold impacts the price of gold mining stocks in a major way. This works great as gold prices rise because gold miners earn more profit, but as gold prices fall, revenues of gold mining operations quickly dry up. In fact, when gold increases, the stock prices of gold miners can increase three times as much. However, the opposite is also true and can be seen with the recent decline in gold prices over the last two years. Gold miners have been some of the worst performers over the last two years as gold came down off its high set in 2012. As gold prices came down to their current levels, investors in gold mining stocks took major losses including some gold miners going out of business. Because gold prices are so influential to gold mining stocks, it is important to keep tabs on major directional changes in its price to protect yourself from losses and get in on future gains.

The Mine’s Potential

Another challenge with mining is figuring out how much ore there is in the mine. When you buy a gold coin or a gold bar, there is no speculation about the gold actually existing because it’s physically in your hand or in your possession elsewhere. With gold mines, there is an estimate of how much gold is still in the mine. Sometimes, this estimate can be incorrect. Of course, it can be wrong on both sides and you can end up with either more gold ore than you thought or less gold ore than the geologists estimated when you bought the land. Of course, in the case of having less gold than you thought, the price of a gold mining stock hit with this news is devastating. Essentially, the market has to reprice the whole value of the company based on the decreased future earnings. When owning shares in a gold mining stock, this is the worst news an investor can hear.

Bad Management

Even the best mining operation in the world with an abundant supply of gold ore can be mismanaged into a huge loss. In fact, inexperienced mining managers can actually take a profitable mine and turn it into a huge cash sucking operation. Mining operations is an extremely specialized field, and subtle decisions can have major impacts on profits. For instance, slight changes in the price of gold can dramatically impact the profitability of any gold mine. Without the experience to know when to ramp up operations and when to only operate at 50% capacity, management can make it cost prohibitive to turn a profit. In addition, there are constant changes to each country’s mining laws and union contracts.

Although the information in this commentary has been obtained from sources believed to be reliable, American Bullion does not guarantee its accuracy and such information may be incomplete or condensed. The opinions expressed are subject to change without notice. American Bullion will not be liable for any errors or omissions in this information nor for the availability of this information. All content provided on this blog is for informational purposes only and should not be used to make buy or sell decisions for any type of precious metals.