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Home >> Why Buy Stock In Gold Mining Companies?

Author: Gold Why Webmaster
Date: January, 2008
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I recently wrote an article explaining why I would avoid gold stocks in favor of bullion. At the end of that article, I explained that investing in gold stocks is a complex topic and I often see myself taking both sides of the argument at the same time. Today, I'm going to look at the other side of the gold coin and explain the top reasons why I think it's a great time to be accumulating shares of stock in quality gold mining companies.

We Are Running Out of Gold

According to Galmarley, all gold ever mined is worth $1.8 trillion dollars. All gold that has not been mined is worth about 40 percent of the mined gold or $0.7 trillion dollars. Adding these two numbers together we get $2.5 trillion dollars worth of gold bullion, both mined and underground. This number may sound high but it is actually really low compared to the current US national debt of $9 trillion dollars. Now, let's factor in the national debt of all other countries and the supply of gold looks even lower. Put simply, the supply of gold is extremely low. Since we are running out of gold very quickly, all gold left in the ground is extremely valuable. Who owns the gold that is left in the ground? Gold mining companies. The very fact that there is not much gold left is a very strong reason in favor of investing in gold mining companies.

Proven Versus Probable Reserves

When investing in gold mining stocks, some jargon that is extremely useful is "proven" and "probable" reserves. Proven means the gold in the ground is proven for sure. Probable means they think the gold is in the ground but it has not been proven. Gold mining companies traditionally trade based on their proven reserves with probable reserves factoring in at a discount. The 40 percent number above is most likely based on proven reserves. What does this mean? If you find gold mining companies that have a high amount of probable reserves that actually materialize into real proven reserves, you could have a huge winner on your hands. Put another way, the more risk you take on the more reward if things go in your favor. This is a high stakes game, but one that may be worth playing with a certain portion of your portfolio.

Gold Mining Company Consolidation

How are businesses valued? There are many factors that go into their valuation with a heavy emphasis on assets and future stream of income. Gold mining stocks are great because they are very heavy on assets, gold in the ground. However, they are a unique case because their assets evaporate over time because the assets are being mined. What happens when they run out of gold? There is no more gold mining company. The business solution to this dilemma is a large number of acquisitions. More than any other industry, you often see a plethora of acquisitions in the mining space. Acquired companies tend to appreciate in value because they are acquired for more than their current share price. To participate in the spoils of this industry consolidation, an investment in smaller gold mining companies that have a lot of proven and probable gold reserves may make sense.

Some Sanity Checks Before You Buy Gold Stocks

Ok, so you're interested in buying gold mining stocks. A few things to note. First, I am not a licensed investment advisor. I am not giving advice but just some commentary. While this article is in favor of gold stocks, make sure to take a look at my article that points out why gold stocks may not make sense. Second, if you do buy, make sure to diversify. Diversification is one of my favorite topics and I have always been thankful for my diversification strategy when the investment road gets rough. Take it slow and place only a well diversified portion of your portfolio in gold mining stocks (a lower percentage than you place in actual bullion or gold exchange traded funds). Third, do your research and then do it again. Research is the name of the game in stock investing, especially in the volatile mining sector. Forth, buy unhedged mining companies. When you buy unhedged mining companies, you participate in gold's appreciation. If you buy hedged companies, however, you are only investing in their mining operation and not the price of gold. Good luck to you in your quest to invest in the gold mining sector!

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