This week I want to look at investing in precious metals through mining companies. Many years ago, people would invest in mining companies as a way of hedging the precious metals market because there wasn’t any other practical way.
There were no gold or silver ETFs and mutual funds were even more expensive than they are today. In the early 1980s, when gold and silver exploded in price, most of the investing was done with physical delivery or through futures contracts, both of which can be very expensive methods of investing in precious metals.
The alternative then became investing in companies that mined gold and silver because, as the price rose, so did their profits since many of the costs associated with mining were static.
Let’s look as some of the issues mining companies face, which you need to take into consideration before investing as an inflation hedge or simply a growth play.
Gold and silver are mined all throughout the world and oftentimes in very harsh conditions like in Alaska. If any of you have watched the Discovery’s show on gold diggers, you know that it is not the greatest thing to do in bad weather or in those latitudes.
Secondly, you have to consider the governmental conditions of the location of the mines. Is this a friendly and stable government to foreign companies and are the taxation policies favorable for profit?
Next are equipment costs. Equipment used to mine minerals is not cheap to purchase or transport. Parts are oft en difficult to obtain in remote parts of the world and repair people are not cheap, either.
Like oil exploration, you never know what you are going to get when you start digging. There are some very smart geologists out there who know what to look for in rock formations to give a company a good shot at a strike. But you can always dig a dry hole and dry holes cost just as much to dig as prosperous ones.
The cost of all this equipment and transportation of workers fluctuates with the cost of fuel. A mining operation uses a lot of fuel and the work is hazardous so wages need to reflect the work and the risk.
Finally, the cost of capital can be crucial for the mining company. Many times the capital dries up just before the final phase of mining and the payoff hits. This can become a death spiral since often the mining takes place where there is a short window of good weather to get the job done before one has to wait until next season.
All of this being said, there are some opportunities to invest in mining companies and make a good return on your money. If a company has proven reserves and the price of the commodity rises this creates an opportunity to cash in on getting those reserves out of the ground and making a good profit.
Most of the major mining operations in the world are incorporated in British Columbia. Many years ago, British Columbia essentially became the best place for companies to base their headquarters because of the favorable tax structure of the province and the stability of the government.
When investing in a mining company, look at all of the fundamental things you look at in any other public company — good earnings, manageable debt, stable and competent leadership, fair pricing of the stock and liquidity.
Additionally, you need to see what their known reserves are and if they hedge the ounces they have in the ground and what the hedging is in relation to the price of the metals.
Finally, is the company diversified with their mining operations or are they locked into just gold and/or silver? Many mining operations also have operations that mine some of the base metals like copper, zinc or lead. These metals will help the cash flow and profitability of the company.
✯ Gary L. Rathbun is the president and CEO of Private Wealth Consultants, LTD. He can be heard every day at 4:06 p.m. on “After the Bell with Brian Wilson and the Afternoon Drive” and every Wednesday and Thursday at 6 p.m. throughout northern Ohio on “Eye on Your Money.” He can be reached at (419) 842-0334 or email him at garyrathbun@ privatewealthconsultants.com.
