It´s a good Time to be a Gold Miner
Gold prices have been on the rise after briefly falling along with equities when investors first ran to cash as the pandemic initially spread to the U.S. Gold futures have gained more than 20% from their March lows to where they are today – trading for more than $1,800 on Tuesday for the first time since 2011.
Meanwhile, producers of the precious metal have seen outsized gains as gold prices have recovered. Since bottoming in March, the NYSE Arca Gold BUGS Index, which represents miners, gained more than 70% through early this week. Comparatively, the S&P 500 index gained around 37% between its early pandemic lows to today.
If gold’s recent surge interests you as an investor, here’s what you should know before you jump into this market:
- Why gold prices are at multiyear highs.
- Miners tend to outperform rising gold prices.
- There are different risks to keep in mind.
- Four gold-mining stocks to watch.
Gold Prices Are at Multiyear Highs
Gold futures hit their highest price in more than seven years last week as traders and investors continued their flight to the metal as a safe-haven investment. Market participants are worried that the economic recovery might not go as smoothly as hoped as the pandemic resurges in parts of the U.S., threatening the reopening of businesses and potentially keeping people homebound longer.
Gold – a competitor of U.S. Treasurys as a safe haven – has also been getting support as reduced interest rates make the precious metal, which doesn’t pay any interest, more competitive with low-yielding government debt.
After spiking during investors‘ move to cash, the U.S. dollar has also been on a downward trend. That boosts demand for dollar-denominated gold by making it less expensive for holders of other currencies.
A key source for gold demand has been physically backed gold exchange-traded funds. The largest of these, the SPDR Gold Trust (ticker: GLD), which buys physical gold to back shares that investors purchase like stocks, is up around 16% year to date and has $67 billion in assets under management.
Miners Tend to Outperform Rising Gold Prices
With that backdrop, it’s unsurprising that the companies that extract gold from the ground and sell it are doing well.
What may come as a surprise to investors who aren’t familiar with the gold-mining industry is that shares often outperform the price of gold as the metal rises in value.
That’s because operating and financial leverage lead to a higher percentage of increased free cash flow, notes Morningstar’s basic materials analyst Kristoffer Inton. Basically, an increase in the gold price adds to cash flow, while production costs and company debt remain the same. The extra value from the free cash flow increases the equity value.
The opposite is also true, Inton says. But in a declining gold price environment, companies can take measures to offset the damage by cutting costs, finding efficiencies or boosting production, he adds.
Different Risks to Keep in Mind
While gold prices, like those of other commodities, can be quite volatile, gold miners come with their own set of risks in addition to their susceptibility to the rise and fall of gold prices.
With miners, investors have to understand that the mines themselves come with production risks. These include the potential for increasing costs and declining ore grades, Inton says.
There is also jurisdictional risk for companies operating mines in less politically stable areas.
By Matt Whittaker, Contributor July 1, 2020, at 9:00 a.m.