Lear Capital: Physical Precious Metals vs. Precious Metals Stocks

Zero Hedge's picture

Sponsored Post by Lear Capital

When it comes to precious metals, an often discussed topic is whether one should own precious metal stocks or the actual physical metals. Here's some things to ponder if you are considering placing money into either.

Let's ask the question. Why does one own metals' stocks? Answer? Because you expect metal prices to rise. Any answer you give after this, takes second place, third, fourth, whatever!

Why does one own the physical metal? Answer? Because you expect metal prices to rise. Basically the same answer.

Here's the catch. Rising metal prices do not guarantee rising stock prices. There's a multitude of variables to weigh, when considering the best way to diversify into the precious metals market. Consider this fact first. The more of a given metal you take out of a mine, the closer you get to depleting it. I don't care what mine you own, every ounce of metal taken from it brings you that much closer to the last ounce it can produce.

This brings up the next point. If one mine produces more profit than the next, which stock would you buy? Naturally, the one that produces at the least possible cost for the highest possible profit should get the nod. Hence, a rising metal price does not guarantee all corresponding metal stocks will rise in lock-step.

Look at it this way. If a given metal goes down in value, it can put a mine out of business. But, the metal itself, will never be worth zero. There are many other variables that can affect a stock value beyond just the price of the metal it mines.

Barrick Gold, said to be the largest gold mining company in the world, may serve as an example that the value of a gold stock is, in many regards, subjective. A Reuters release, reported Barrick stock fell 6.73% the day it announced its intent to purchase Equinox Minerals, an Australian Copper mine.

"Barrick explains the move down," said Francis Campeau, broker at MF Global Canada in Montreal. "I'm wondering if the gold players are going to steer away from Barrick to get to a more gold play."

Another variable affecting the price of precious metals and metals' stocks is inflation. On one hand, inflation and inflation fears help drive metal prices higher. On the other, inflation means higher mining costs and a strain on profitability. Let's call it the Doctor Dolittle "pushmi-pullyu" effect.

Other factors that could adversely affect the price of mining stocks, may include, worker strikes, safety shutdowns, accidents, profit forecasts and PR. On the flip-side, factors that slow production, even if for a short time, could help to drive metals' prices higher. Granted, the effect may only be "transitory," but present, nonetheless. As for PR, that's just a beauty contest. May the prettiest ads win.

The bottom line is, rising metals' prices are guaranteed to increase the value of a metals' portfolio. But, when it comes to stocks, there is no rule that says rising metals' prices must raise the value of related stocks.

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rosiescenario's picture

"Why does one own metals' stocks? Answer? Because you expect metal prices to rise."


Not necessarily true....maybe I buy a mining company producing a metal I do not expect to rise or fall very much, but that mining company is sitting on an immense amount of economical reserves that no one in the market has given them credit for.


Or, many years ago, I buy DeBeers at $2.50 / share, not because I think diamond prices are going to be moving much, but because the company has $5 / share cash sitting in Belgium while the whole world believes So. Africa is about to implode.


Or I buy a small silver miner because they have what appear to be immense unproven reserves, but I know the company is doing a drilling program to prove these out over the next few years and expect the stock to reflect their success and move up 5X.


There are many reasons to buy a mining company even if you believe whatever it is they are mining may have a static price. Another example, I buy ERGO (many years back) because they have a new concentration method to extract gold from all the old and huge tailings dumps in So. Africa....they end up making a fortune not due to gold going up but due to their technology and implementation.


Personally, I do not think many investors really understand how mining works as a business....it is both an asset play (reserves and new discoveries) and an operating play (generating cash from digging out something at one cost and selling it at another). Improvements in flotation and mining techniques may provide a windfall even though the end product might even go down in price.

NonAggressionPrinciple's picture

I do expect metals prices to rise, but when I read articles like these it makes me want  the stocks even more.  Investors are so down on many PM stocks not performing they are a relative bargain.


Buy low, sell high...remember?

bankrupt JPM buy silver's picture

" Because you expect metal prices to rise"

Not really.  If you are going to hit the CHIMU like Tinka Resources then 100 mill ounces at $25 or $50/oz doesnt really make a differece to me ;)

Thomas's picture

I am at a loss to understand the mining stocks. I have owned them for years and they have gone up in price, but they do not act leveraged to the price of metals. If they were lagging, readying for a moonshot, you would expect huge earnings and low P/Es. Good luck finding those. Maybe the mines really are "holes in the ground with liars at the openings."

A Lunatic's picture

I'm sure we can thank the EPA (among others) for some of this disjointedness?

FreedomGuy's picture

Mining stocks can make you money even when metal prices are flat. They could improve process, find a lucrative new vein or have a nice steady margin where production costs are significantly lower and steady. They are easier to sell, as well. I like both for different points in time and market conditions.

Old Poor Richard's picture

Well miners just suck right now, so maybe that's a clue?

Take a look at the chart of SIL:SI, see that miners did great last winter, then never recovered fully after the January bottom.  I made plenty in SLW between Feb though April, but SLW is special, GDX,GSXJ,SIL fucked me.

My 401k, where most of my stuff is, now sucks, too.  I made a lot in Select Gold and Select Energy, but now they're flat to down.  Miners suck, equities suck.  Need to park the money somewhere else, cause it's only going to slip further.

Need to figure out where to park my money.

Is the dollar going to strengthen short term at the "end" of QE2, or is it going to plummet in order to compete against the Yuan?

What I'm hoping for is the dollar to strengthen, gold and silver to touch base with their 150MA, equities to correct hard.  Then Zimbabwe Ben cranks up the presses again, and we ride it up again.

slvrizgold's picture

Yeah, the stocks have lagged the metal for a long long time, but there's this thing called REVERSION TO THE MEAN.    And it always reverts to the mean.

As an aside, I would note that just because the large name PM stocks have been dullards, there has been lots of spectacular upside action in the small to midsize companies for those who know the sector well.

And if you believe that PM equities won't eventually reflect the rise in metal prices with awesome eps and share price, then you are so dumb you probably had to repeat 3rd grade.

Phillips Capital's picture

most boring article ever

Phillips Capital's picture

one could assume that since we can't find jack shit for a bullish vote on mining stocks these days, that may signal an opportunity to buy at the bottom of sentiment. we all know where buying paper silver (or any stock) when sentiment was at it's height gets us. 

AgShaman's picture

Long term bloodletting of the miners and their relative under-performance comparative to the physical price of metals has the curious wafting of a "set-up"...and a consolidation phase. I sense mid-tiers and larger producers are eyeballing many Juniors like the Wolf drooling over LRR-Hood. Some of these Explorers may have attractive properties...but perhaps not the cash reserves to get them to production. While they may not be deserving of representing the lion's share of your portfolio....some portion may not be such a bad bet...compared to alot of stocks on a market riding north of 2008 price points. I can't shake the notion that the DOW is undeserving of being above 12k....and over-ripe for a serious beatdown (purely what my gut tells me though as I don't care to follow it that closely anymore)