Asset Class: Gold Mining Stocks

DON'T LIKE IT    

Some investors purchase stock in gold mining companies as a complement or substitute to owning gold bullion.  The earnings of most gold mining companies are expected to be leveraged to changes in the price of gold, so the idea is that if you are bullish on gold prices, you should be even more bullish on mining companies.  However, our purpose for gold bullion is to provide diversification benefits in the event of monetary depreciation, not as a bullish bet.  Thus, gold mining stocks are not a good substitute for gold bullion.

Several arguments support our view.  The first comes back to the matter of purity.  While they may be levered to the price of gold, gold mining companies do not provide as pure a play on gold as some investors would hope.  As with any company, operational and financial risks are present which can impair the profitability of a gold miner.  Mine accidents and closures, increased government regulation/taxation, rising energy and labor costs, and debt defaults are a few examples of how individual gold mining companies could stumble even if gold prices are rising.

Another concern with gold mining stocks is something you may have heard about in a market crisis: “all correlations go to 1”.  This means that risky asset prices that normally don’t move together may all go down in a crisis.  So while gold mining stocks are generally more correlated to gold prices than stock prices, they may follow the broad stock market down in a deep decline.  Gold miners tend to provide good diversification when stocks are rising (and you don’t need the diversification), but poor diversification when stocks are plummeting (and you really wish you had some diversification).

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The preceding is an excerpt from the Modus Advisors Special Report titled, "Like It or Not? The Modus Advisors approach to Asset Class Investing".

You can download the complete report here.

We also have a podcast discussion of the report available here.