Invest in gold bullion or gold-mining companies?

If you own a gold fund, you’ve probably heard about the big gains gold bullion has made this year.

You may also be wondering why your gold fund hasn’t shared in any of those gains.

The short answer: If you invested in a fund that buys the shares of gold-mining companies — as many

do — you probably lost money this year. If you bought shares of a fund that buys the metal itself, you

made money.

That’s not the normal order of things. Typically, gold miners fare better than the metal itself in a bull

market for gold. But these are not typical times.

The argument for gold-mining stocks is fairly simple. When the price of gold rises, a company that

produces gold sees its earnings increase at a faster pace than the metal itself. Let’s say you owned a

mine that could produce gold for $1,100 an ounce. When gold is $1,200, you make $100 an ounce in

profits.

Let’s say that gold jumps from $1,200 to $1,500 — an increase of $300, or 25%. For the gold miner,

however, profits have jumped from $100 to $300 — a 200% gain.

TRACK STOCKS: Get real-time quotes with our free Portfolio Tracker

Gold bullion has risen to $1,721.10 from $1,531 at the start of the year — a 12% gain. But the

average gold-mining fund has dropped 6.6%, according to Lipper. What gives?

Gold-mining stocks are still stocks. And the public is much more leery of stocks than gold, says Robert

Cohen, manager of the Dynamic Gold and Precious Metals fund (DWGOX). “In a market where there’s

a perception of large financial problems, people get nervous about stocks,” Cohen says.

Gold-mining stocks now have competition. The first fund that invests only in gold bullion, the SPDR

Gold Trust (GLD), made its appearance in 2004 — and since then, gold-mining stocks have largely

lagged behind the metal, says John Hathaway, co-manager of Tocqueville Gold fund (TGLDX). “Gold-

mining funds are no longer the only game in town,” Hathaway says. “Now, just one click of the mouse

and you have GLD.”

And, says Cohen, gold-mining companies are seeing increasing costs. As the price of gold rises, many

countries where gold miners operate are now increasing their demands for a cut of the profits, Cohen

says.

A bigger problem than costs, however, is the cost of starting new mines. Not only are there large

environmental expenses in opening a mine, but it’s more expensive to line up money for a new one.

“Ore grades are down, discoveries are down, environments are more hostile, and infrastructure is less

available.”

When gold was below $500 in the early 2000s, gold miners were hanging on by their fingernails,

Hathaway says. Now they’re less inclined to take big risks. “They’re saying, ‘We were with you when

you were down and out, we don’t want to be risking our newfound dreams of growth,’” Hathaway

says.

The question now: Gold or gold stocks? “Most people are better off owning the metal,” says Hathaway.

When you own the metal, you don’t have to worry about missed earnings or disappointing production

results. You only have to worry about whether gold prices will go up or down.

But gold stocks are historically cheap, Cohen says. “You have to accept that they are cheap and may

stay cheap. The question is, what is the catalyst that brings them back.”

Newmont Mining (NEM), for example, is selling for about five times earnings before interest, taxes,

depreciation and amortization, says Hathaway. The stock also has a 3% dividend yield.

If the stock market rallies, gold miners could outperform as investors regain confidence in stocks. But

fears about the fiscal cliff — a combination of tax hikes and spending cuts that could send the

economy reeling if Congress doesn’t act by Dec. 31 — are keeping investors wary of stocks.

Article Source: http://www.usatoday.com