The Risks With Investing In Gold Miners

October 16, 2010 | By | Reply More

As the boom in physical precious metal prices reaches new heights week after week, we get the impression that the producers, aka the miners beavering away to fill the vaults of governments, banks, ETFs, jewellers et al., are being left behind.

Sure they have risen in recent weeks, but so far they have been outpaced by the physical metals although there is no denying that there have been some outstanding exceptions. So the question is – when will gold miners catch up with this runaway market?

In these cases it has usually been more the result of the impact of new discoveries and/or their development than because they have been in lock step with the rising prices of their end products

Interest Grows in Gold & Silver

That the precious metals market, with gold and silver to the fore, is enjoying a long term bull market with probably quite a few more years to run has become the general consensus and does not now seem to have many doubters.

This is evidenced by a steadily increasing interest in the gold market by both professional investors and Joe Public and is underscored by their diminishing confidence in the greenback and the deficiencies of the current Obama administration in dealing with the abundant problems that continue to surface after decades of smug, indulgent mismanagement of the worlds most vibrant and vital economy.

Profit Potential Amongst Junior Miners

There is risk attached to investing in miners, arguably more so than in any other market sector. Careful and thorough research is required for success, but if you get it right the rewards can be quite spectacular. This is particularly true of the junior mining sector, the start ups, exploration and development companies that need capital to fund their operations in the tight lending environment of today.

This is where top class management comes into its own, established, highly reputable and experienced company leaders at the helm will have the confidence of lenders and participants in their operations. This is the starting point of any evaluation of a junior miner’s prospects.

Buy Outs & Partnerships

With world gold production coming down year on year and demand escalating rapidly, the big boys, those established majors in the mining industry, are becoming more anxious to buy out or participate financially in promising juniors so if you can find the right prospects by exercising due diligence you can hit the jackpot in a very big way.

For those of us who prefer the safe, well trodden path, then stick to the majors.

Established Practice to Hedge Risk

It has been the practice for many miners to sell forward varying amounts of their annual production to hedge against a collapse of the market. By doing this they are ensuring that they can continue to operate profitably in bad times.

The downside to the practice of hedging is apparent in the current precious metal bull market when those miners committed to forward sales are losing significant extra profit as the market continues to hit new heights. Fortunately there are those optimistic forward thinking CEOs that have discarded this policy in the present circumstances and their shareholders are reaping the rewards.

Keeping a Lid on Costs

Extraction costs are also an important factor. Clearly the lower the cost of production the more profitable the mining operation and, in the event of a major drop in metal prices, the cost effective miner will be among the last to succumb.

Political Risk Assessment

Political considerations should also feature importantly in any analysis of a mining company’s prospects. The major companies will be diversified amongst a number of countries with differing political outlooks. Balance out the differing political risks and stability of the countries where they operate before committing your investment dollars.

Miners to Watch

Among the mining companies we like are AngloGold Ashanti (NYSE:AU), GoldCorp (NYSE:GG), Kinross Gold (NYSE:KGC), Hecla Mining (NYSE:HL) NovaGold Resources (NYSE:NG) but beware, some are more speculative than others and our only recommendation is that it may be worth your while to do some extensive research of the above as excellent opportunities exist as miners catch up with the physical market.

Final Thoughts

As we have often mentioned silver is a smaller but more volatile market than gold. In recent weeks silver has outperformed gold by a considerable margin, causing the gold/silver ratio to fall well below 60, above which it had lingered for some years. Historically the ratio has been between 50 and 55, sometimes dropping to the low forties.

With this in mind we are expecting silver to continue to outpace gold with the ratio reaching 50 as our target and until then any spare change we have will be going into Ishares Silver Trust (NYSE:SLV) whenever we see a pullback opportunity.

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