Why Gold Stocks?

They Provide the Biggest Bang for your Buck.

During a gold bull market, I have a strong preference for gold stocks over either gold bullion or gold coins, largely because gold shares are leveraged to the price of gold. In other words, as the price of gold rises, profits of gold-mining stocks rise more in percentage terms. Generally, over the longer term, the share prices of major gold-mining firms rise by a factor of two or three times more than the price of gold.

The reason gold-mining profits are leveraged to the price of gold is obvious. A rising gold price does not lead to a rising cost of production. Therefore, for companies that are already profitable, incremental revenues received from selling gold at a higher price flow straight to the company's pre-tax bottom line. For companies that are unprofitable, a rise in the gold price can suddenly lift them into profitability and with that, the share prices can sometimes rise dramatically.

Successful junior gold-mining companies, or those companies that are not yet in production, frequently rise by a factor of 5 to 10 times more than the price of gold. Not only does a rising gold price make the gold in the ground more valuable, but junior gold-mining firms frequently make gold discoveries that raise the intrinsic per share value very dramatically, compared to what a discovery of similar size would do for a senior mining firm. For example, if a major mining firm with 100 million ounces and 200 million shares of stock outstanding discovered a million-ounce gold deposit, it would have increased its reserves by just 1% and added 0.005 oz. gold/share. On the other hand, if a junior gold-mining firm with 20 million shares outstanding and just 200,000 ounces of reserves made that same one-million-ounce gold discovery, it would have increased its reserves by 400% and the gold equity in the ground would have risen from 0.01 oz. gold per share to 0.06 oz. gold/share. Therefore, in a secular gold bull market, I am partial to gold shares, but even more so toward junior gold-mining shares.

Another reason I favor gold shares is that while gold bullion itself was made illegal to own during the 1930s, gold shares were not. We hope our government will never make the same foolish decision to make gold ownership illegal again. But if they do, there is a precedent for believing gold shares may not be affected.