This year has seen precious metals perform very strongly. Last week, both gold and silver set new all-time-high prices. With global geopolitical uncertainty remaining elevated, I would not be surprised if precious metal prices continue to perform strongly. That may have many investors thinking about whether to buy shares that can give them exposure to gold, silver or other precious metals.
I understand the potential appeal of that idea. But for now I have decided not to invest in any precious metals-related shares.
Here are a trio of factors that form part of my consideration.
The precious metals market is cyclical
Gold is seen (not necessarily correctly) as a safe haven in times of uncertainty. It is unsurprising that it has been performing so well in the current geopolitical environment.
I regard timing the market as impossible. But in broad terms, I expect the historically cyclical pattern to keep playing out.
When investors are very confident and perceive geopolitical and economic risks to be diminishing, gold’s appeal will wane and its price will fall. That may not happen for some time yet. Meanwhile, precious metals may continue to go from strength to strength.
But, as recent record prices demonstrate, we are already well into the pricing cycle for precious metals. That makes me less interested in buying shares to gain exposure to gold or silver. I prefer to invest closer to what I see as the bottom of the cycle.
Diversification matters – always
Gold specialists are making hay while the sun shines. The Pan African Resources share price has more than tripled so far this year, while Caledonia Mining Corporation has more than doubled.
Some companies mine or sell not just gold, but also silver. They are also in clover. Since the start of the year, for example, Fresnillo is up 343%. The Hochschild Mining share price is up 111%.
But when a company’s fortunes are too closely tied to one or two commodities, that can mean its business model lacks diversification. The result can be strong performance when one or two precious metals do well – but also a sharp downturn when prices fall.
Looking for a proven business model
That helps explain why, when I do look for mining shares to buy, I prefer to focus on companies with diversified operations.
Rio Tinto (LSE: RIO), for example, produces gold at its Kennecott site in the US. Kennecott also produces silver. Not only that, it also produces copper cathode, molybdenum, tellurium, selenium, carbonate and sulfuric acid. Rio’s business is highly diversified between different metals as well as geographically.
Such a diversified approach may mean Rio Tinto’s overall performance lags gold and silver pure plays when the precious metals market cycle is moving upwards.
This year, for example, its share price gain of 18% is nowhere near as strong as some of the businesses I mentioned above.
I also look for a proven business model. Some mining companies have rights to mine but are not actually doing that yet, or making any money. Last year, for example, Rio Tinto made over $11bn in net profit!
Still, I see the current elevated price of some metals as a risk for Rio Tinto’s share price. At this point in the metals cycle, I have decided against investing.
