Investing in gold or gold stocks may see volatile performances over shorter time horizons. Many external factors can impact gold related investments, such as the fluctuation of the dollar and market’s concerns over inflation, which normally don’t have as much an immediate effect on stocks in other sectors.
Because of such a close correlation between gold and general economic conditions, gold is often used as the hedge against things like mounting trade deficit and government debt. The relationship between the two are inverse in its nature.
Trading of gold stocks likely see on a daily basis opposite movements between general market indexes and gold stock prices. But over longer periods of time, gold price has continually gone up. All else held equal, gold stocks should follow the same pattern.
A few operational elements are important to profits and growth of gold mining companies and thus the performances of their stocks: proven and probable gold reserves, annual production amount, and cost per ounce. Not only a company’s gold reserves are valued as natural resources on its balance sheet; but they are what its mining activities are ultimately dependent on. Pay attention to both the total amount of reserves and their annual growth.
Also, to help put the numbers in perspective, know that the total amount of gold ever mined in the world is about only 160,000 tonnes as of the end of 2009. No high gold price in the market can earn a company enough revenue if no adequate gold production. Cost per ounce is used to compare with the changing gold price. As long as the rate of cost increase is not exceeding the rate of price increase, the same profit margin is maintained.
The gold mining industry is a very capital intensive business, as both exploration and production activities demand large amount of capital injections. While issuing new shares and taking on additional debt are ways of meeting capital requirements, they dilute existing shareholders’ value in the short run and impose operational constraints and financial liabilities. A desirable approach to funding would be to accumulate enough earnings over time.
The right gold stocks are likely companies that have reported growing operating cash flow year after year. Operating cash flow is income adjusted for unpaid receivables and non-cash cost items, especially accounts payables and other accrued expenses that could save a company certain cash outlay for the time being.
Not all gold stocks are right for all investors. Some prefer growth stocks, while others go for value shares. P/E ratios for gold mining companies can range from trading price being over one hundred times of earnings to many only in the single digit. Still many more have no calculated price-to-earnings ratios at all, because of present operating losses.
It’s a matter of investment philosophy. To some people’s view, future investment returns may well lie in the bargain prices of their stocks, but to others’ belief, it’s worth the risk to expect potentially above-average growth.