Sunday, July 31, 2011

Gold Stocks Versus Gold Bullion

In a period of rising gold prices, such as the last decade, gold stocks would be expected to perform well.  But the mining business is very difficult, and it is particularly difficult for large companies to increase their production, or even to maintain current production levels.  

There are various reasons for the difficult economics of the business.  As with the oil business, the easily accessible reserves have long since been exploited.  In addition, with a large base of current production, it is difficult to find new resources that are large enough to result in a material percentage gain in overall output.  In addition, production costs that include energy, raw materials, and labor, have increased steadily.

Newmont Mining’s latest earnings report illustrates the challenges.  Its net income per share rose only 1.3% over the prior year, even though the average gold price realized by the company rose 26% during the period.  Its production costs rose from $507 per ounce to $588.

I have long favored gold bullion, or financial instruments linked to bullion, to mining stocks.  Over the past five years, the price of gold has risen 150%, while Newmont’s share price rose 14% and the GDX Index of mining stocks rose 47%.   With a correction in the gold price in its eleventh consecutive year of gains quite possible and a potential decline in the stock market also likely in my opinion, I would trim or sell gold stocks and defer additional gold bullion purchases.

Steve Lehman

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