Comparing Gold and Gold Mining Companies: Considerations for Investment
Warren Buffett has publicly (and frequently) written about what he considers the folly of investing in gold: Gold doesn’t produce any tangible values – neither products nor services. This article argues why Buffet is right about gold. However, are gold mining stocks a better investment than gold bullion?
This article looks at the performance of gold bullion versus gold mining stocks. Which one is better to own? Which one is riskier? Gold or gold mining stocks? Should you buy the metal or the companies/stocks? The gold price has outperformed the gold mining stocks by a wide margin.
At the end of the article, we explain why we believe gold bullion and miners are poor investments in the long run.
Is it better to buy gold or gold miners (gold mining stocks)?
Which way is best to get exposure to gold? Should you buy the metal or get exposure via mining companies?
Let’s jump right into it. We calculated how an investment in gold and gold mining stocks performed from 1985 until the summer of 2020:
We used the XAU index as a proxy for the gold miners (blue line), and it’s pretty clear that gold mining stocks underperformed the gold price by a wide margin from 1985 until the summer of 2020 (gold is the red line).
We believe it makes sense. There are plenty of arguments why mining stocks over time is a poor investment:
Gold mining risk:
Let’s look at some of the risks of owning gold mining companies. We have never owned mining stocks, and we most likely never will for these reasons:
Miners face exploration risk (gold bullion doesn’t):
Drilling might come up blank. It costs a lot of money to research, drill, and explore. Most of the time to no avail. CAPEX is huge.
Miners have management risk (gold bullion doesn’t):
As with any company, you face risk from poor management decisions.
Miners have huge environmental risk:
Regulation might change at a dime. The red tape for exploring gold is enormous and most likely continues to increase. Add to this litigation costs. A tail event can create substantial financial damage.
Miners are at the mercy of the bullion price (pricing risk):
The gold producers are at the mercy of the gold price, which they have no influence on. If prices fall, a gold miner can be put out of business.
Miners can face financial risk (gold bullion doesn’t):
Mining and exploration are naturally very capital-intensive and cyclical – a nasty combination. It’s a very fragile business:
Add financial leverage into the mix, and you face a high risk of financial ruin or potential dilution risk.
Many speculators buy miners when they believe the gold price will go up because of the financial leverage in the mining companies. This might work in the short run but not in the long run.
Miners are prone to geopolitical risk:
Gold miners are exposed to risk from bad political decisions. Many miners operate in regions where the rule of law is weak. Add to this increased risk of heavy taxation after years of government overspending in many parts of the world. Mining rights are easy prey for cash-strapped governments.
Miners have productivity risk:
Fuel is one of the biggest expenditures of