With the gold price recently breaking out above the $1,400 level for the first time since 2013, many investors are getting excited about the asset again.
Now I’m not its biggest fan as an investment as it doesn’t generate any cash flows or income. That said, having a tiny bit of exposure within your investment portfolio (~5%) as a hedge against uncertainty isn’t the worst idea. If stock markets were to crash, your related investments may provide an element of protection.
But what’s the best way to get exposure to gold? Are companies in the FTSE 100 and the FTSE 250 that mine the yellow metal, such as Antofagasta, Fresnillo, Polymetal, and Centamin, a good way to profit from price movements?
Having invested in a number of related miners pre-Global Financial Crisis (GFC) – when the gold price was soaring — and losing a LOT of money during the period, I would generally advise investors to steer clear of gold mining stocks. In my opinion, they’re not a good way to profit from movements in the price of gold, nor are they a good long-term investment.
The first thing you need to understand about such stocks is that they’re essentially a leveraged play on the price of gold. So when the price is moving higher, they can perform very well. However, if the price crashes, gold stocks can be hit hard, meaning they’re quite risky.
A great example of this is Centamin, which mines gold in Egypt. In 2008, the gold price fell from around $1,000 to $712 – a decline of just under 30%. However, over this same period, Centamin shares fell from around 78p to just 22p, representing a decline of over 70%. So, be aware that gold stocks can be highly volatile.
Many moving parts
The other main issue you need to understand about gold companies is there are a lot of moving parts. To be highly profitable, everything needs to click.
For example, a gold company needs to have finance in place. Its mine needs to be operational. Setbacks such as broken equipment or staff strikes need to be minimised. The weather also needs to be good.
Ultimately, there are many different factors that can take their toll on success, and that means you could actually miss out on profiting from gold price gains if the company can’t get its act together. When you invest in gold stocks, there’s no guarantee that you will actually profit even if the price rises.
For this reason, I think you’re better off buying gold bullion (bars or coins), or a gold exchange-traded fund (ETF) if you’re looking to profit from related price movements.
A poor long-term investment
Finally, like all mining companies, gold companies have very little control over the prices they receive for their products. This means that profits can fluctuate significantly which, in turn, means that dividend payouts can fluctuate. From a long-term investment point of view, that’s certainly not ideal.
If you’re looking to grow your wealth, I think you’re much better off investing in companies that are able to generate relatively consistent profits.
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Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has recommended Fresnillo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.