Gold stocks aren’t much different than any other type of stock. They just happen to be shares of companies that produce gold.
These companies mine the ore that contains the metal and sell it to refineries. The process is similar to oil or any other natural resource in the ground.
The reason why gold stocks perform better than gold is simple: They offer leverage to the gold price. That’s why the returns can be spectacular.
The word “leverage” usually means borrowing. That’s not the case at all in the gold market.
If you aren’t familiar with the concept of leverage in gold stocks, here’s a quick example of how powerful it can be:
Say the price of gold rises from $1,300 to $1,400. That’s roughly an 8% gain. If you own physical gold, you’re up 8%.
Now, say a mining company owns a million ounces of gold in the ground, and gold is trading at $1,300. The value of the gold in the ground isn’t simply $1.3 billion (1 million ounces x $1,300/ounce). Instead, the gold in the ground is worth much less than that, because it will cost a lot of money to extract.
Say it costs the company $1,250 per ounce, all-in, to mine the gold. At a gold price of $1,300, the company has a potential profit of $50 on each ounce of gold.
However, if the price of gold rises only 8% to $1,400, the company’s profits per ounce increase by 200% ($1,400 – $1,250 = $150 profit per ounce). This small move in gold can cause the stock price to increase 40%, 50%, or more. This is why a small increase in the price of gold can cause a gold stock to soar many times that amount.
It’s happened before…
Below are the historical returns for gold producers during four separate cycles when gold boomed: 1979–1980, 1981–1983, mid-1990s, and 2001–2006.
These are not hypothetical returns. They are real.
First up, the king of all gold bull markets: 1979–1980…
Gold more than tripled during this period. But gold stocks more than quadrupled.
Returns of Producers from 1979 to 1980
|Campbell Lake Mines||$28.25||$94.75||235.40%|
|Giant Yellowknife Mines||$11.13||$39.00||250.40%|
This wasn’t the only time gold stocks soared…
From 1981 to 1983, gold producers returned over 70% on average. And this happened in less than two years.
Companies like Agnico Eagle and Campbell Red Lake climbed over 120%. And Sigma shot up 73%.
These profits stemmed from a mere 10.8% rise in gold.
There was another boom in the 1990s. The average gold producer went up more than 200%…
Cambior rose 124%. Kinross Gold returned more than 190%. And Manhattan skyrocketed over 760%.
All while gold only rose 8%.
Then another big boom hit from 2001–2006. This one rivaled the boom of the early 1980s.
Gold returned 158%, while the average gold producer gained over 400%.
Newmont shot up 270%. Gold Fields soared over 500%. And Goldcorp returned over 800%.
As you can see, an increase in the price of gold (even a small one) can lead to huge returns.
You can make a fortune in the gold market. But you must understand market cycles.
Gold stocks move in extreme boom and bust cycles, more so than most other markets. Contrast that with “noncyclical” businesses, like those that sell toothpaste or laundry detergent. Demand for these types of everyday items is steady whether we are in a bull or bear market.
Demand for natural resources like gold is highly cyclical. Just like with oil, investors pour money into gold miners during boom times.
A gold stock might soar 500% over a three- to five-year raging bull market. Then collapse 90% in six months in a nasty bear market. Similar to what we’ve seen over the past five years.
From late 2011 to late 2015, gold fell 42%. It was a nasty bear market, sending companies out of business and delivering huge losses for investors. While the fall in the price of gold was drastic, the fall in gold mining stocks was even worse.
Over that same period, the NYSE Arca Gold BUGS Index – the gold mining stock index – fell 83%. So as you can see in the following chart, gold mining stocks (shown in blue below) fell at twice the rate of gold (shown in black).
However, that’s only the average. Some companies fell even more.
Now the gold market is changing course.
As we mentioned above, gold prices are 26% higher this year.
The Market Vectors Gold Miners ETF (GDX), which tracks the performance of all the major gold producers, is up 115% from its January low. But certain gold miner stocks are up even more. The table below shows how much several big gold miners are up over this year. As you can see, Barrick Gold Corp. (ABX) is up 138% since January 19. Meanwhile, Yamana Gold Inc. (AUY) is up 215%.
|Barrick Gold Corp. (ABX)||138%|
|Newmont Mining Corp. (NEM)||141%|
|Yamana Gold Inc. (AUY)||215%|
|Agnico Eagle Mines Ltd. (AEM)||103%|
|Randgold Resources Ltd. (GOLD)||65%|
In the chart below, we charted the major cycles for gold stocks from 1975, when gold again became legal to own in the U.S., to the present. Eight distinct cycles played out during this time.
Gold stocks have been in the second-deepest bear market since 1975. It’s even worse than the selloff following the 1980 mania.
In other words, this is an incredible opportunity.
But you don’t just want to buy any gold stock…
It’s important to pick the best gold stocks. Because not all gold stocks perform the same in a cycle.
Like in any other industry, the stocks of stronger companies will go up more than those of the weaker ones.
And there is a small area of the gold market where gold stocks can go “vertical.” It’s here where investors can make 10x, 20x, or even 50x their money.
Editor, The Casey Report
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