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Forget investing in gold! I’d invest in gold mining companies right now

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Should you invest in gold or buy shares in gold mining companies? While gold is the common denominator, they have some significant differences in risk and reward. Here, I’ll explain why I’d forget the yellow metal itself, and go for mining stocks.

Gold is flying high this year

The gold price started 2020 at little more than $1,500 an ounce. Last month, it reached a new all-time high of over $2,000 an ounce. This 33% rise contrasts starkly with the FTSE All-Share index, which is down over 20%.

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However, in inflation-adjusted terms, this year’s gold price remains behind previous peaks in 2011 and 1980.

Going for gold

A number of things can support a higher gold price, including currency devaluation or inflation, economic uncertainty or recession, and political instability. Right now, gold has a lot going for it.

  • Money-printing on an unprecedented scale is debasing currencies.
  • Governments and central banks have been signalling they’re prepared to over-stimulate at the cost of higher inflation.
  • We’re in a recession.
  • There’s considerable uncertainty about how long it will take economies to recover from the punishing impact of the coronavirus pandemic.
  • US-China tensions are just one of a number of uncertainties in the political sphere contributing to trepidation about future developments in global relations.

Gold is often considered the ultimate ‘safe haven’ for investors during turbulent times. Given the scale of what could be long-running macro issues, it’s no surprise many analysts are forecasting the price of gold will be making not just new highs, but new inflation-adjusted highs over the next few years.

Why I’d buy shares in gold mining companies

As I’m writing, the gold price is 28% higher than at the start of the year. However, the shares of many gold mining companies have risen a lot more. This is because, all else being equal, any increase in a miner’s revenue will translate into a much bigger increase in its profits. It’s called operational gearing.

However, miners also come with operational risk. For example, a Covid-19 outbreak at a mine could temporarily halt production. There’s also political risk, such as a government nationalising its country’s mines.

Gold itself isn’t subject to either of these risks. However, if you invest in gold mining companies, you can mitigate the risks by diversifying across a number of stocks. I think the reward of potentially higher returns – including cash dividends from most producers – makes the risk worthwhile.

Which gold mining companies should I invest in?

Investors have plenty of gold mining companies to choose from on the London stock market. They range from giant, blue-chip producers to tiny, speculative explorers.

Personally, I’d go for a small portfolio of geographically diversified, revenue-generating companies. The table below summarises some key information on five gold stocks I’d be happy to buy today.

 

Share price rise

Index

Market cap (£bn)

Location of mines

Dividend yield

Fresnillo

+97%

FTSE 100

£9.4bn

Mexico

1.2%

Polymetal

+67%

FTSE 100

£9.2bn

Russia and Kazakhstan

4.6%

Centamin

+64%

FTSE 250

£2.3bn

Egypt

5.0%

Hochschild

+23%

FTSE 250

£1.2bn

Peru and Argentina

0.7%

Pan African

+104%

FTSE AIM 50

£0.5bn

South Africa

3.7%

I’m bullish on the gold price and miners’ shares for the foreseeable future. I’m not alone. Legendary investor Warren Buffett recently bought a stake in a mining company.

However, be aware that operational gearing works both ways. A falling gold price would likely lead to a deep reversal in gold mining companies’ profits and share prices.

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G A Chester has no position in any of the 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.

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