How to choose a gold mining stock

“Gold is not everyone’s idea of a suitable portfolio investment – former Prime Minister and Chancellor of the Exchequer Gordon Brown once dismissed it as a ‘barbarous relic’ – but the precious metal’s rise to new all-time highs is eye-catching all the same,” says AJ Bell investment director Russ Mould.

“This may be due to how US inflation is proving sticky as the American economy runs hotter than expected, or how central banks continue to acquire the metal to diversify (and perhaps boost the quality of) their reserves, or perhaps how investors are seeking an alternative haven as US Treasury prices slide. Either way, gold is going up and some investors may now wish to think about how to get involved, if they think the metal fits with their overall portfolio strategy and goals.

“Gold itself offers no yield, has limited industrial use and comes with a cost of ownership, in the form of storage and insurance, so many portfolio builders will still fight shy of embracing the metal, especially when they can get returns from cash in the bank that currently exceed inflation.

“But gold is durable, has a history of being money since time immemorial and is difficult and expensive to produce, so it can be seen as a store of value at a time when inflation is eroding the purchasing power of money in the West. Supply of gold grows much more slowly than that of ‘money’ and it is just possible that the inflation seen in 2021 to 2023 is part of the bill for the interest rate cuts, additional Quantitative Easing and money creation deployed by central banks to see the globe through the pandemic.

“Contrary to expectations, inflation looks to be reaccelerating in the USA, where consumer price inflation, producer price inflation and the US Federal Reserve’s preferred benchmark, the Personal Consumption Expenditure (PCE) index, are all picking up pace once more.

Source: FRED - St. Louis Federal Reserve database, US Bureau of Labor Statistics

“Whether this proves to be an uncanny echo of the 1970s, when two or three waves of inflation washed over the USA (and the UK for that matter) remains to be seen, but it looks as if bond markets are at least considering this possibility, especially as oil and copper prices remain firm. The yields on US Treasuries are creeping higher, and their prices falling, even as stock markets are still pricing in three interest rate cuts from the US Federal Reserve in 2024.

Source: LSEG Datastream data

“The divergence between gold prices and US Treasury prices is particularly startling and suggests that commodity and bond markets are starting to price in a rate of inflation that is higher-for-longer, a message that in no way fits with the equity markets’ preferred narrative of a cooling in inflation, a soft landing for the economy and a pivot to interest rate cuts from central banks.

Source: LSEG Datastream data

“This may persuade some investors to think about gold once more, although again the lack of yield and industrial use, and negative carry relative to cash, could deter many.

“They may instead therefore decide to research gold miners, as the successful ones do generate cash and pay a dividend, thus offering a yield. Their earnings and cash flow, and therefore potentially their dividends, are also highly geared to the gold price.

“However, not all gold miners are equal, and investors must patiently research them and apply six tests to see whether they may be suitable for portfolio inclusion or not:

Whether a gold miner is already producing, in the exploration phase or is in the process of obtaining (and making the most of) a license.

If it is in the production phase, the next task to is to assess the size of its resource and the production profile of existing mines. There is little or no point buying a gold miner if it is about to exhaust its reserves and deplete its mine.

Source: Company accounts

Where the company operates, and the risk (or otherwise) of difficulties with local governments over mining rights and taxes, as well as the susceptibility of individual mines to problems posed by difficult conditions, such as extreme weather.

The company’s all-in sustaining cost (AISC) of producing an ounce of gold, as this will reveal how profitable (or otherwise) the firm will be relative to the prevailing metal price. Some miners publish a cash cost figure, but this may not include third-party smelting, refining, transport costs, local taxes and office running costs so it may not give the full picture. Key cost variables include staff and diesel and fuel, and they can be affected in turn by local currency movements in the countries where their mines are situated.

Source: Company accounts

The experience and skill set of the management team and executive board.

The miner’s balance sheet and how much cash or debt it has. The more of the former and the less of the latter the better, especially if gold prices drop.

“Finally, having assessed the miner’s operations, investors must study the valuation currently attributed to its stock. This can be done using earnings- or yield-based metrics, but both can be deceptive, especially if the gold price starts to swing around a lot. A further option is to look at net asset, or book, value. This will not move around so much, and should grow over time, at least if the gold price remains firm and profits start to pour out of the ground.

“America’s Newmont Mining paid 1.7 times book value to acquire Australia’s Newcrest in 2023 and Canada’s $325 million friendly bid for America’s Argonaut Gold valued its target at 0.33 times net asset value, perhaps as a reflection of its net debt position and relatively high AISC of $1,722 an ounce in 2023.”

Source: Company accounts, Marketscreener, consensus analysts’ forecasts

Source: Company accounts, Marketscreener, consensus analysts’ forecasts