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Protecting Your Portfolio: Should You Buy Gold Or Gold Miners?

Many investors consider gold to be a safe haven, a hedge against inflation and a hedge against financial calamity. Indeed, a small allocation to gold in your portfolio is a prudent diversification tool but it has its drawbacks.

For example, physical gold becomes expensive and is bulky to store in any large quantity. Additionally, there are plenty of gold-focused investment funds on the market but some charge hefty management fees and others are difficult to understand.

Moreover, gold by itself doesn’t generate a cash flow, which can hold back returns. In the words of Warren Buffett:

“If you buy an ounce of gold today…a hundred years from now, you’ll have one ounce of gold, and it won’t have done anything for you in between. You buy 100 acres of farm land and it will produce for you every year…”

However, the shares of gold miners will produce a cash flow for investors. Companies such as Randgold Resources (LSE: RRS)Fresnillo (LSE: FRES)Centamin (LSE: CEY)Highland Gold (LSE: HGM) and Acacia Mining (LSE: ACA) are highly exposed to the price of gold and offer investors a dividend payout when the going is good.

Underperformance 

Still, the majority of gold miners have underperformed the price of gold over the past five years.  Specifically, over the past five years the price of gold has risen 13.3% but Highland Gold has fallen 54%, Centamin has fallen 40% and Acacia — formerly African Barrick — has declined 53%.

On the other hand, the larger miners of Randgold Resources and Fresnillio have outperformed gold over the past five years. The two miners returned 28% and 31% respectively for the period, excluding dividend payouts. What’s more, over the past ten years, Randgold has outperformed the price of gold by over 600% and Centamin has outperformed by 183%. 

So the data is mixed but Randgold seems to be the standout performer.

Unfortunately, investors are willing to pay a premium for this best-in-class performance. The company currently trades at a forward P/E of 30.8 and offers a token dividend yield of 0.6%. Fresnillo is the other standout performer of the group.

As the world’s largest producer of silver and Mexico’s second-largest gold miner, Fresnillo has many advantages over its smaller peers. But once again, investors are willing to pay a premium for the company’s shares. Fresnillo currently trades at a forward P/E of 52.8 and offers a token dividend yield of 1.1%.

If you’re looking for a relativity cheap high-quality gold miner, Centamin could be your best bet. The group is forecasting a production cost of around $700 per ounce this year, far below the current gold price. At present levels, and according to current City forecasts, Centamin currently trades at a forward P/E of 13 and is in line to support a dividend yield of 1.6% this year. 

Russian gold producer Highland Gold could be too risky for some investors. The company has failed to perform over the past few years but looks to be one of the sector’s cheapest bets. Highland Gold currently trades at a forward P/E of 4.3 and is set to support a dividend yield of 13.9% next year. 

And lastly Acacia Mining, which is in the middle of a turnaround plan. Analysts believe that Acacia is set to profit this year from lower fuel costs in its open-cast mines. However, the group currently trades at a forward P/E of 18.6 and is set to support a dividend yield of 0.9% this year. This valuation may be too rich for a turnaround play.

May not be suitable 

Some gold-mining stocks have outperformed the physical metal over the past few years but there’s no guarantee that this will continue. However, mining stocks do offer investors a level of income and provide more flexibility for the average investor.

It all comes down to your investment strategy and I strongly recommend that you do your own research before making any trading decision. To help you assess the company, our top analysts have put together this new report from The Motley Fool.  

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.