Investing in Gold and Silver Miners

Gold has been a store of wealth for thousands of years and has been used as currency for a long time before fiat currency (paper money, notes or bills) was used. Silver has similarly been used for coins for many centuries in many countries around the world. Gold coins still have a similar value now in real terms to what they had years, decades and centuries ago (i.e. you could still buy a broadly similar amount of food or property now as you could in the past, while the dollar value of such items appear to increase as the dollar sinks) Gold and silver prices are however very volatile and do not pay a dividend (in fact they cost money to store)

Gold or silver mines are a far riskier proposition (hence the warning in the famous quotation attributed to Mark Twain: "A gold mine is a hole in the ground with a liar on top."), but a profitable mine may even pay a dividend, or spend profits on expansion, potentially making you a profit above that of the inflationary increase in the gold price.

Valuing a gold mining share is difficult and prone to error or assumptions, so this kind of investment can be very risky, especially in the case of small miners which will not be as well researched as the bigger mining companies, for which the amount of gold in the ground and the costs of extracting it are easily available in many financial publications. Investing in small miners can however result in big gains (or losses) because you are speculating on big gold discoveries. Small miners are also usually last to start growing in size during a gold price or mining boom, because of lack of media exposure, analysis or research.

The usual method of valuing a gold mining company is to assume a cost of gold production of $650 per ounce, so as the gold price rises above this value the value of future production of the mine increases at a faster rate and with the gold price at close to $1200 (at time of writing) miners look very profitable.

As much of the increase in gold price is because of the drop in the value of the dollar the local production costs and pay for workers etc. will increase eating into the profit. Another problem is the use of derivatives, by the gold mining company, to hedge for future gold prices, so the existence or use of such contracts needs to be understood to fully determine the influence of the gold price on the share price.

There are many companies that make at least some of their money from gold mining: The big companies such as Rio Tinto and BHP are perhaps the most obvious choices, with good research available from many analysts or the Russian gold miner Petropavlosk, formerly know as Peter Hambro Mining (LSE: POG) and smaller players such as the London listed Silver and Zinc miner, Minco (MIO) which has silver mines in Mexico.