Why You Need Gold Miners In Your Portfolio In 2018

December 27, 2017

Why You Need Gold Miners In Your Portfolio In 2018

I recently wrote about how gold is an essential part of a portfolio. However, today I want to dig deeper into what kind of gold investments could be the best fit your portfolio because it’s all about your personal preferences and every gold miner is different.

Let’s start with the basis of gold in an all-weather strategy.

Gold As Part Of An All-Weather Strategy

There are two macroeconomic environments where gold as a hedge does well: when there is inflation, and especially when there is an economic slowdown and inflation.

Figure 1: Gold price since 1973. Source: Gold Price.

In the 1970s, gold went from $64 per ounce to over $600. From 2001 to 2011, it went from $250 to $1,700. Since then, it has stabilized at $1,250.

Now, the chart above shows how the price of gold declined from 1982 through 2001, and has been declining since 2011. Therefore, gold has to have such a position in your portfolio that allows for constant rebalancing where positive returns may or may not happen.

What’s important is that when positive returns happen, they are huge. It isn’t unusual to see the stock of a major gold miner increase 5-fold and stocks of minor gold miners even 20 or 50-fold. However, losses of 90% are also something that can easily happen and it all depends on the kind of gold miner you own.

Both Barrick Gold (NYSE: ABX) and Newmont Mining (NYSE: NEM), the two largest global gold producers, quintupled in the 2000s only to fall 90% after 2011.

Figure 2: Newmont mining historical stock price. Source: Google.

Considering this, a key aspect of gold investing is patience, proper portfolio allocation, and rebalancing.

We’ll now discuss what your portfolio allocation should be and discuss the type of miner that could best suit your portfolio.

Gold Miners

Every gold miner is different and their stock prices will react differently to changes in gold prices.

There are a few factors that can help you decide which miner to choose for your portfolio. The factors are mining costs, reserves, debt, cash flows, and jurisdiction. If we take a look at several gold miner presentations, we can see what one thinks about the other which is a great way to benchmark a sector. However, it’s always good to look at various presentations because there is a lot of information omission. Let’s see about reserves.

Gold reserves show how much gold is still underground, and shows the potential the company offers, especially if gold prices increase.

From Barrick’s presentation, we can see that they like to brag about having the highest level of reserves which amount to 86 million gold ounces.

Figure 4: Barrick’s view of global gold reserves. Source: ABX.

A company that Barrick omits from their presentation is Polyus Gold (ADR: OPYGY), a Russian gold miner that has a similar lever of reserves but a much longer average life of mine.

A longer life of mine means that the sunk costs needed to set up a mine—which are often the largest part of mining costs—are going to be exploited for a longer time and a miner will need less new capital investments to keep production stable. A shorter life of mine means that the miner will be forced to use its cash flows to make acquisitions or invest in new projects which is always risky.

Figure 5: Life of mine average and yearly gold production. Source: Polyus.

So the longer the life of mine is, there is more of a possibility for more cash to be deployed back to shareholders.

Gold miners have this strange attitude of really going crazy when gold prices increase, and make extremely expensive acquisitions using debt to fuel future growth. When that happens, it’s time to sell. The time to buy is when it looks like the whole sector will go bankrupt and divestitures are on the daily menu. But if you want safety, you can buy miners with a long life of mine, low mining costs, and no debt.

Debt levels are also very variegated between miners. Harmony Gold (NYSE: HMY) likes to present itself like the miner with the lowest debt, but is also currently the miner with the highest mining costs.

Figure 6: Net debt to EBITDA in the gold sector. Source: HMY.

The higher the debt a company has, the higher default risks are in the case of lower gold prices. However, if gold prices increase, the debt issue quickly becomes obsolete and stock prices usually shoot up.

The situation is similar with mining costs. The higher the mining costs are, the tighter current margins will be. However, in the case of higher gold prices, margin expansion is exponential and the stock price will have an extreme reaction.

A low-cost producer that is always profitable is usually traded at a premium. There is also probably a dividend there and if gold prices increase, margin expansion isn’t that significant. All-in sustainable cash costs of around $600 are extremely low while the highest costs are close to the current price of gold as it simply doesn’t pay to produce with higher costs.

Figure 7: Gold mining cost curve. Source: Polyus.

Another significant risk for miners is political risk. What you don’t want is to see gold prices rise and then get all your profits confiscated by an unfriendly government.

Figure 8: Political risk. Source: Agnico.


To sum things up, these are the factors you should watch for when analyzing a gold miner as a potential investment:

    • Current and future mining costs,
    • Debt,
    • Reserves and potential growth,
    • Cash flows,
    • Gold grades,
    • Political risk, and
    • The price in relation to all of the factors above.

Looking at these factors will give you a clue of how large your gold portfolio should be.

As for the risks, let’s say that gold miners with high mining costs and high debt that are barely surviving now offer the largest upside in the case of higher gold prices, but the downside could be larger than 90% in the case of lower gold prices and total loss shouldn’t be excluded.

The downside with a gold producer that has low mining costs and no debt would be less, but not by much. Let’s say 50%. However, such a miner probably wouldn’t go bankrupt in the event of lower gold prices, but the upside would also be relatively limited as the margin expansion would be much smaller.

So how much should one devote to gold miners in their portfolio? My target allocation is from 5% to 10% with a few miners that fit your portfolio and provide diversification.

If your portfolio is overall defensive, low cost miners with no debt would fit best. If your portfolio is aggressive, low margin miners would be a better fit.

If you aren’t exposed to gold in your portfolio, you should really rethink your exposure in order to have some protection in the case of inflation and more monetary easing rounds in the medium-term. If gold prices fall, be ready to rebalance accordingly.

I’ll dig deeper into creating an all weather portfolio in an upcoming article. An interesting diversification play is to own a gold and copper miner that offers you inflation protection but also diversification in relation to economic turmoil.

There are other inflation protective assets that we will discuss so you will be able to see which asset classes give the best all-weather diversification to your portfolio.

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