Thursday, September 07, 2006

gold stocks or gold coins?

I can't understand all the excitement and belief in gold and silver mining stocks. Of course the theory is that mining stocks will rise faster than the price of gold. In economic hard times, gold mining stocks are supposed to be one of the few market sectors that prosper. Gold writers say the XAU and HUI (gold mining stock indexes) have to lead the spot price of gold.

I just don't agree. There are good reasons why the price of gold might rise, but gold mines might not be able to profit from that rise. It is all about cost. The costs of mining gold are all going up, and they could easily outrun the price of gold itself. Mining costs consist mainly of:
  • energy
  • raw materials, such as steel
  • highly skilled and specialized labor
  • specialized and expensive equipment
  • capital

    Costs for all these items are rising fast. The price of base metals has been outpacing gold in recent years. Costs of capital (interest rates) are rising. Remote mining locations, usually in undeveloped nations, also increases costs for the mine. The skilled labor has to be brought onto the location, and housed and fed. The steel and equipment have to be imported and transported. Energy supply has to be secure (note that before the age of fossil fuels the energy source was usually slave labor).

    A final risk to mining operations is the risk of nationalization, or psudo-nationalization. A nation hosting foreign mines on its territory might not want that operation to shut down, especially if it employs lots of local labor, or trains workers in skilled positions. But they might decide to tax the operation so that little (if any) profit leave the country.

    And what would happen if, in a time of rising precious metal prices, gold mines have to shut down because they can't make a profit? The result would be a decrease in the supply of gold - thus driving prices higher. Of course not all gold mines will find it hard to profit. Some mines are more profitable than others. But the costs and risks are variable and uncertain. I'm not going to try to pick a winning gold stock. If you can pick em, or trust some gold stock guru to find them for you, maybe you'll be happy. Or not. I'd stick with shiny round coins, its so much simpler.
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