How to choose a gold miner stock investment now the Gold Price has dropped $300 from its top...
GOLD MINER STOCKS under-performed the Gold Price dramatically on the way up, and they have been slaughtered on the way down since March's top of $1,032 per ounce, writes Julian Phillips of the Gold Forecaster.
So is the day of the gold miner equity over...or is there a way to select a strong gold mining stock and profit in such a market?
The key is to look at the long-term criteria for selecting gold mining shares. The mind set for the successful long-term gold miner investor has to recognize that gold shines amid uncertainty, doubt and fear about the future. So to get the best out of that situation, one has to select a gold mining stock that also does well in poor conditions for equities more broadly.
A miner that can perform well in bear markets will perform well in a bull market, too. More importantly, a Gold Mining stock that performs well in both will, in the long-term, usually far better than any other investment one can have.
What's more, there are some gold miner stocks that have outperformed the rest by a huge margin. What do they have that others don't?
For 30 years, a culture of investing only in a rosy future has been the guiding light for all stock selection. In this culture of "earnings don't count", the focus was on present and future capital growth alone. But now Gold Investment prices have risen because the future has lost its rosy hue, and the dark clouds of uncertainty have raced towards us from the far horizon. This tells fund managers, who dominate the tide and current of the equity markets, that they should adjust the basis for stock selection.
In selecting a gold miner to buy, they now have to define the threats to equity price appreciation. For Gold Mining stocks, they are:
#1. Increasing political uncertainty
In developing countries, increasing taxes and royalties have and will impact profitability as government attitudes to mining changed from welcoming those who benefited the nation to resenting the profits made by companies from their assets.
Underground assets are worthless until they are mined, but greed eventually surfaces when the profits paid to hard work are seen. An investor must select a company that mines gold in countries where the first attitude persists and will continue to do so. If that legal atmosphere changes, then one should disinvest.
#2. Price in uncertainty and falling confidence
Paradise may come, but why pay a price that expects it? With the very high price/earnings ratios we saw in the broader stock markets, far too high expectations were priced in – so they had to come down. For those who only paid prices that foresaw a dim future, their dividend stream more than compensates for the loss of rosy capital gains. And if the right price was paid, in burgeoning bull markets prices may rise so high that a sale with a view to re-buying on any dips will give intermediate capital gains.
To pay too high a price for a gold miner stock now will leave the dividend-flow hopelessly low. So buy at prices that allow for a good flow of income. Right now, many good Gold Mining stock prices reflect just such prospects.
#3. Measure dividends correctly
Gold miner investors need to measure their potential dividend flow levels in the light of 'risk free' investments such as Treasury bonds. If you can get 3.7% on US government debt, then with an investment horizon of, say, three years, you would hope to see a total dividend paid equal to three years of that 3.7% risk-free yield (some 11.1%) and which is set to rise thereafter.
This describes the days we have now moved into, days when you must see an income return on your money, one where bright hopes for the future are not part of the decision-making formula. After all, gold shines in bad times! But gold miners may not.
So how can one find a share which will see rising dividends? These six criteria apply:
- The gold miner must have sufficient reserves to last the long term and preferably shallow in the ground;
- Look for policy and competence to continue to grow reserves, so that even if the Gold Price remains static, cash flow will grow;
- Seek the ability to control costs, right down to the extent that profitability is not eroded through rising costs (a major problem for gold miners since 2003). It has to be said that in the climate most favorable for Gold Bullion, mining costs will run higher. Therefore the company profile should evidence an ability to retain profitability in the face of rising costs. This secures the ability to pay rising dividends;
- A sound well funded balance sheet, with low debt or zero debt;
- Competent management with a sound record of performance;
- A policy of dividend rewards for shareholders.
In summary, when choosing a gold miner for your portfolio of Gold Investment, consider:
- Will your investment pay a dividend or simply re-invest earnings to extend the life of the mine at the expense of dividends?
- Will dividends come in the future, if so when?
- How will those dividends compare to the return on Treasuries?
- Will dividend flow overtake Treasury interest income within three years or so and rise thereafter?
If the gold mining stock you're researching provides a rising dividend flow, it will justify your investment in bear markets and pay for itself. In a bull market for gold, you should also see capital appreciation of an extraordinary nature. But we must emphasize that the dividend flow is the foundation of your gold miner stock selection.
If dividends are not there, or they are just a hope, then the miner has not and will not perform well. The gold mining stocks that are performing well are paying their shareholders and justifying why they should continue to hold them, in the face of those oh-so-safe Treasury bonds.
But remember, gold miner stocks are equity investments, they are not Gold Bullion itself. Therefore they have to meet equity criteria, and they are exposed to all the standard stock-market risks.