[miningmx.com] — FOR many years – perhaps forever and currently too – investors have believed the prices of gold shares will outperform the gold price itself, even if the latter increases.
This refers especially to the gold price in rand and that’s why gold shares have for many years enjoyed the status of a good hedge against a weak currency.
That’s simply not right. Gold is a good investment and it’s also a good hedge against any currency uncertainty. But please don’t give that status to gold shares.
The myth – no, let’s tone that down abit – the perception that gold shares will fare better than the gold price stems from the inherent leveraging advantage offered by gold shares.
Let’s say the gold price is $1,000/oz and production costs at a good mine are $800/oz. The mine will show a profit of $200/oz. Now if the gold price were to rise virtually overnight to $1,200 the profit would of course double from $200 to $400/oz.
In a sensible and balanced market, the price of the gold share should double, or at least increase much more than the modest 20% increase in the gold price.
Unfortunately, it’s not that simple. One of the complications investors must bear in mind is nowadays the very learned analysts also build the amount of reserves into their models and many other complicated things we ordinary mortals don’t even understand.
On a more comprehensible level, there’s the proven long-term ability of especially goldmine managers to squander the benefit of a higher gold price or a weaker exchange rate within a few months.
The benefit of a higher gold price seldom – if ever – reaches the profit figure, not to even mention the mine’s cash flow.
In the example above, where production costs were $800 and the gold price $1,000/oz, investors can assume with certainty the production costs will rise equally swiftly to $1,000/oz if the gold price were to go up to $1,200.
Investors shouldn’t doubt mine managers’ ability to push production costs up quickly.
Of course, speculative investors prefer marginal gold mines. These are mines where the cost is, for example, $950/oz and the gold price $1 000/oz. The small
profit of $50/oz must surely increase to $250 if the gold price increases suddenly.
That’s the theory of the dream world of investors in gold shares.
Gold was an excellent investment over the past year – even in rand – but especially in US dollars, British pounds and euros you built up legally or illegally in offshore island bank accounts over the past few years.
Incidentally, you can buy gold legally in SA. There’s no longer any premium on Krugerrands and, unlike paper money, Absa’s paper gold GLD is guaranteed by
the exact amount of gold stated on the receipt.
– The article first appeared in Finweek
