Precious Metals or Mining Stocks?

2010-JUN-28

Adam Brochert writes --

Those who want to invest in the precious metals sector are confronted with a decision: should they buy precious metals (i.e. gold, silver, and platinum) or mining stocks? The answer partly depends on factors like risk tolerance, timing, and understanding of the mining industry. However, certain basic principles can help guide those interested in profiting from the secular precious metals bull market.

From an investment standpoint, precious metals have one feature that separates them from common commodities like oil or food: the ability to buy and store the item directly as an investment strategy. Though there are paper proxies for commodities these days, it is impractical for a typical investor to buy physical oil or corn and store it. On the other hand, it is easy to directly purchase and store precious metals, whether taking personal possession of the metal and/or entrusting its storage to a reliable custodian like GoldMoney.

Mining is a difficult and politically sensitive industry. Individual firms may fail or succeed. In aggregate, however, there are times when mining stocks are relatively cheap compared with the underlying metal itself and present a good buying opportunity for long term investment gains. One of the simplest ways to recognize a buying opportunity in mining stocks is to compare the price of mining stocks to the price of the underlying precious metal. This is most easily done by using a ratio chart of the price of gold divided by the price of a basket of blue chip mining stocks. Here is an historical chart to show this concept, using goldgrams and the blue chip Philadelphia Gold and Silver Mining Index (XAU):

Identifying a buying opportunity is only the first step, for then the investor must choose the stocks in which to invest. There are small-cap, mid-cap and large-cap mining companies. Small-cap mining firms are early stage companies that may or may not have found any actual precious metal deposits. Large-cap firms are blue chip, experienced precious metal miners that typically operate several large functioning mines. Mid-cap firms generally operate at least one producing mine.

Small cap firms have the highest risk thus potentially the greatest reward. For most investors, a basket of mining stocks to reduce company-specific risk makes the most sense. Precious metal mutual funds or mining stock ETFs can provide such diversification. Mining stocks are volatile, but can provide greater returns relative to the underlying precious metal during certain periods.

For most investors, the choice is clear. First, accumulate physical metal as the anchor to your portfolio. Gold, silver and platinum are safer and devoid of the risks that accompany their respective mining stocks (e.g., poor management, mining accidents, political risk). Accumulating physical metal on a regular basis is the best and safest way to profit from the long-term precious metals bull market. GoldMoney offers a secure, convenient and safe way to purchase and store precious metals for those ready to take the first step.