Gold vs Gold Mines, Which Is The Better Choice?

This contribution comes from the Boon & Knopers Substack

Most people who have bought gold will probably have heard of investing in gold mining stocks. Or maybe even have been tempted to buy these shares, with a view to extra returns when the price of gold rises. The theory behind this is simple: The profit margin of a gold mine is the difference between the cost of production and the current gold price. If the gold price rises, it acts as a lever on the profit margin of the gold mine.

Unfortunately for the gold miner investor, this theory has not held true in the last ten years. The gold price has only risen further and is well above the level of 2011, while the value of a basket of gold mining shares (NYSE Arca Gold Miners Index) has yielded nothing on balance over the last ten years and is more than half lower than in 2011, when both gold and gold mining stocks rose to record highs.

The return on gold has been significantly higher than that of gold miners over the past thirty years (Source: Bloomberg, via the Financial Times)

How is this possible?

Previous analyses for Holland Gold (2017, 2021, 2022) shows that most people would be better off with physical gold than with a portfolio of gold mining stocks. The main reason is that physical gold has no counterparty risk, while gold mining stocks have numerous risks. From the April 2022 analysis for Holland Gold:

"For example, the government of a country can force a gold mine to cease production. It can also happen that a gold mine has to sell its gold to the central bank of the country. This is usually done at a less attractive rate or in the local currency, which reduces profitability. When the price of gold rises sharply, the government of a country may decide to designate the precious metal as a strategic asset. As a result, the precious metal is not allowed to leave the country.

In addition, there are the normal business risks. Think of strikes and production problems, but also of environmental pollution or disappointing yields from a gold vein."

These are quite a few risks, while people buy physical gold to avoid risk. In that respect, gold and gold mining stocks are two completely different asset classes. And this is exactly the reason why we are in the Model portfolio of Geotrendlines hold only physical bullion (and especially gold) and no position whatsoever in the gold mining sector.

At a time of increasing geopolitical tensions and economic warfare, more countries will recognize the strategic value of a gold stockpile and the physical possession of gold will only become more important, both for central banks and individuals.

This explains why:

1. Central banks expand and repatriate gold stocks

2. Demand for gold storage is rising, while ETF gold stocks are falling

3. The price of gold has risen much faster than the valuation of gold mines

(Photo: Knut Erik-Helle)

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On behalf of Holland Gold, Paul Buitink interviews various economists and experts in the macroeconomic field. The aim of the podcast is to provide the viewer with a better picture and guidance in an increasingly rapidly changing macroeconomic and monetary landscape. Click here  to subscribe.