Followers of Warren Buffett got a bit of shock on 14 August when his Berkshire Hathaway investment group filed its latest form 13F. It revealed, among Berkshire’s trades during the second quarter of the year, a $564m purchase of close to 21m shares in gold stock Barrick Gold.
Buffett watchers were surprised, because he’s previously spoken dismissively of gold. However, there are important differences between investing in gold and investing in a gold miner. Here, I’ll look at these differences, and address my headline question: Should you follow Warren Buffett and buy gold stocks?
Warren Buffett on gold
Buffett once famously said: “[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it.”
His aversion to the yellow metal is because “it has no utility”. It’s an asset that produces nothing, including providing no income by way of interest or dividends.
Gold stocks are different
Mining gold is another matter. If a company can dig it out of the ground, and sell it at a higher price than the cost of mining it, the business makes a profit. And because it makes a profit, owners of gold stocks may see the tangible reward of cash dividends.
Gold miners are a leveraged play on the gold price. This is due to their operational gearing. For any readers who are unfamiliar with the term, it’s quite simple to understand.
Let’s say a gold miner produces and sells ‘X’ amount of gold one year with the gold price at $1,500 per ounce. The following year it produces and sells exactly the same amount (at the same cost of production), but the gold price is 20% higher at $1,800 per ounce. The table below shows the potential effect on the company’s profits.
|
|
Gold at $1,500 per ounce |
Gold at $1,800 per ounce |
Increase |
|
Revenue ($m) |
100 |
120 |
20% |
|
Cost of sales ($m) |
(70) |
(70) |
0% |
|
Gross profit ($m) |
30 |
50 |
67% |
|
Admin, exploration & other operating costs ($m) |
(20) |
(20) |
0% |
|
Operating profit ($m) |
10 |
30 |
200% |
This is operational gearing in action. Due to the big uplift to profits, owners of gold stocks may enjoy higher dividends or special dividends when the price of gold is strong.
Should you follow Warren Buffett and buy gold stocks today?
The gold price made a new all-time high of over $2,000 per ounce earlier this month. However, many analysts believe it could go a lot higher yet. This is because the macro-backdrop — including the debasing of currencies by unprecedented government money-printing — is highly supportive of the gold price.
I remain bullish on gold stocks. Due to political risk (many gold miners’ assets are in far-flung places), and operational risk (for example, a mine suffering a temporary shutdown from a Covid-19 outbreak), I’d spread my investment across a few miners.
Three gold stocks I’d be happy to buy today are FTSE 100 giant Polymetal International, and FTSE 250-listed Centamin and Hochschild.
Polymetal’s assets are in Russia and Kazakhstan. City analysts’ forecasts suggest buyers of the stock at the current price can look forward to a dividend yield of 4.4%. Centamin’s producing assets are in Egypt. This one’s prospective yield is 5.2%.
Finally, Hochschild’s assets are in Peru and Argentina. Its operations have been impacted by Covid-19, and it isn’t currently paying a dividend. Forecasts for next year imply a yield of 1.1%.
