This is the 11th in a series of 11 Posts that will be published on this Blog. All 11 Posts are filed under the Blog Category ‘Gold as an Investment’ and can be accessed by clicking here. We hope you find this Post Series useful.

While preparing this Post Series, I found two recently published books I think particularly helpful: The Goldwatcher: Demystifying Gold Investing, John Katz & Frank Holmes, 2008, John Wiley & Sons, Ltd. and Guide to Investing in Gold and Silver, Michael Maloney, 2008, Hachette Book Group USA. I highly recommend both. Where I have adopted ideas from those books, I have put them in italics. Page references to The Goldwatcher and Guide to Investing in Gold and Silver are denoted by (Goldwatcher – page xx) and (Guide – page xx) respectively. I also recommend www.theGoldwatcher.com Blog and www.GoldSilver.com, websites related to those respective books, to those of you interested in gold. Subsequently I found a 3rd recently published book, Buy Gold Now, Shayne McGuire, 2008, John Wiley & Sons, Ltd. Like the other two, Buy Gold Now is available at Amazon.com. Again, I recommend this book to you. Page references to Buy Gold Now are denoted by (Buy Gold Now – page xx).

General Conclusions

My reasoning behind my conclusions with respect to Gold as an Investment are set out in this Post Series. Succinctly, they can be summarized as follows:

1. Gold is ‘real money’, fiat currencies are not. This is because at any point in time gold satisfies all components of the definition of ‘money’ where as a ‘store of value’ that definition in part means that ‘money’ must be able to be reliably retrieved and ‘predictably useful’ when retrieved. Fiat currencies do not meet this test as ‘money’.

2. At any point in time the U.S.$ is a measure of the price of gold, and while theoretically a measure of its purchasing power at that precise point in time, it is not a measure of its value in the context of gold being a ‘safe haven holding’.

3. At any point in time Gold’s value needs to be thought about in the context of its then current and prospective purchasing power, having regard to prevailing and prospective macro-economic conditions, and related supply/demand factors.

4. Whether the future economic circumstance is inflationary or deflationary, from my own perspective some gold is a good thing to own as a ‘safe haven holding’.

5. Owning shares in gold mining companies is a high-risk endeavour. In my view, only sophisticated investors who do their own extensive due diligence, or do their own due diligence in conjunction with their investment advisors, and have:

• their own opinion on the direction of the gold price at any given point in time; and,

• a working knowledge of the business risks faced by a gold mining exploration or producing company

should own shares in gold mining explorers and producers. Even then, such investors need to have a high risk tolerance, and ought not to invest funds in gold mining companies they can’t afford to lose all, or a substantial part, of.

Conclusion #4 – Gold Mining Stocks

1. As I see it, reaching an opinion on whether one ought or ought not to own Gold Mining Stocks requires far more complex analysis than assessing whether one ought or ought not to own physical gold as a ‘purchasing power hedge’ in uncertain economic and geopolitical times. Essentially I see physical gold and gold mining stocks as quite different asset classes. Simply put:

• Physical gold is physical gold. The variables that principally affect its price denominated in U.S.$ principally relate to point in time macro-economic and supply/demand issues.

• On the other hand from an investment perspective arguably few business ventures are as risky as mining exploration companies and producers. The principal reasons for this go well beyond the macro-economic issues and the physical gold supply/demand equation that affect the price of physical gold. This Post discusses a number, but far from all, of these ‘mining company risks’. For a more detailed discussion of Mining Company Valuation and related risks readers can either refer to the Post Series on this Blog (a Series of 17 Posts) found under the Classification Valuation of Mining Companies, or can find the same information in a single PDF document titled Valuation of Mining Companies under the E-Learning Tab on the Main Navigation Line of StockResearchPortal.com.

• In my view speculating or investing (and I believe there is a clear difference between the two) in gold mining stocks requires a high level of investor and investor advisor sophistication, and a willingness on the part of both to do serious research and due diligence at an individual company level. I do not believe investing in gold mining stocks is for the ‘faint of heart’, yet the financial rewards can be great if the ‘right’ investment is researched and made.

• Having said those things, as noted in The Goldwatcher: “Gold mining stocks will remain popular with investors when bullion is in an upward trend. Investors are attracted to the mine as operational leverage causes the shares to increase by a greater factor than the gold price. When gold declines, however, mining stocks fall by a greater proportion than bullion. (Goldwatcher – page 37).

2. Importantly, I see individual gold mining companies sub-divided by ‘type of company’ as follows:

• exploration companies who have not as yet found NI 43-101 Resources or Reserves;

• exploration companies who have found NI 43-101 Resources or Reserves, but have not as yet completed a pre-feasibility and/or feasibility study;

• exploration companies who have completed said feasibility studies, but have not as yet committed to funding and developing mining infrastructure;

• exploration companies who are in the process of ‘evolving themselves’ from exploration companies to producers; and

• producing companies.

I see each of these ‘company types’ having a quite different ‘risk profile’ one from the other, and hence I see them each as a distinct asset class.

Mining Company Risks

1. Gold mining companies – be they explorers, ‘want to be producers’, or producers – are subject to at least the risks set out in the following paragraphs 2 – 10.

2. At both the exploration and producer levels they are subject to the political and economic risks of the country(ies) in which they principally operate, and to substantive government (including environmental) regulation.

3. In the case of Small Cap Mining Companies in particular (be they explorers or producers) there typically is a dependence on company management, and a lack of ‘critical mass’ at the management level that typically is not present to the same degree in large companies.

4. At both the exploration and production stages (and all stages in between) gold mining companies are dependent on a continued flow of external financing and a competent Board and Management team to effectively spend monies raised in the furtherance of their project(s).

5. At all times their share prices and ability to raise new financing on reasonable terms (or in some market conditions raise new financing at all) are subject to stock market vagaries and volatility in times of both normal and abnormal trading patterns

6. They have no control or influence over the pricing of their mineral outputs, these being driven on world prices that historically have been cyclical.

7. At both the explorer and producer level they are dependent both on the available external and internal (i.e. company specific) infrastructure available to them for power, ore processing, transportation, water, and so on

8. At the explorer and especially producer level they are capital intensive and utilities dependent, with attendant cost structure variations over time (typically both capital and operating costs increase at least with inflation) related to (among other things):

• both new capital and repair and maintenance capital costs;

• labour availability and costs;

• direct and indirect energy costs; and,

• changes in environmental costs both during the period of resource exploitation and at the time of mine closure and environmental remediation.

9. Successful mining projects have each have their own finite life, based on the projects resources and economics related thereto. This makes gold mining (or any mining project based company) different than most commercial ventures in that at least in theory have for ‘value analysis’ purposes an infinite economic life

10. Whereas risk may diminish through the various stages of mine development from initial seeding funding through exploration to either sale of reserves (typically to a ‘major producer’) or production, risk at virtually all times remains higher than the risk investors accept in more conventional investments that consistently generate positive free cash flow.

Some Other Things to Consider when Investing in Gold Mining Companies

1. If one is interested in considering investing in one or more gold mining stocks in the current environment (or for that matter at any time) I think investors should carefully consider at least those things listed in the previous section, and in the following paragraphs 2 – 14. Anyone reading this Post should assume this list is incomplete. Again, for a more complete discussion of Mining Company Valuation and related risks readers can either refer to the Post Series on this Blog (a Series of 17 Posts) found under the Classification Valuation of Mining Companies, or can find the same information in a single PDF document titled Valuation of Mining Companies under the E-Learning Tab on the Main Navigation Line of StockResearchPortal.com.

2. Analyze prior promises: be extremely hardheaded and cynical in your assessment of individual gold mining investments. Critically analyze prior management promises against actual performance. In this regard, I suggest you focus on whether:

• companies that raised money in the last three years through a private placement or prospectus offering spent that money in a way that resulted in NI 43-101 Resources or Reserves believed to have a chance of commercial exploitation; and,

• in the case of producers they achieved or under/over achieved their gold production guidance measured in ounces.

3. Cash on hand: recognize that in today’s environment ‘cash on hand really is king’ in the context of funding ongoing operations in circumstances where raising new capital is difficult to impossible. Look for companies with enough cash on hand (or in the case of producers expected to be generated) to further prove up existing NI 43-101 Resources or Reserves, and who have cash on hand and expected to be generated from operations, net of liabilities, to adequately fund at least their next year’s business plan. Both my personal experience and antidotal evidence have convinced us that companies with only limited cash or without cash are finding it increasingly difficult to raise new equity. Where a Junior Explorer in mid-December, 2008 is successful in closing a financing it typically is doing so from a poor negotiating position – resulting in greater existing shareholder dilution than likely would be the case in more normal markets.

4. Failure to exploit opportunities: if an gold exploration company raised money in the past three years and failed to find exploitable NI 43- 101 Resources or Reserves we suggest you consider carefully how this reflects on company management.

5. Does the company have NI 43-101 Resources or Reserves? If not, it is not unreasonable to think that risk typically is greater than if a company has such Resources or Reserves.

6. Quality of assets: consider the quality of the properties owned by each company in the context of whether they may be attractive to an acquirer or merger partner. Given current market conditions it will come as no surprise to us if there is a flurry of merger and acquisition activity among Junior Miners.

7. Evidence of experienced management – look for recent Board of Director and management changes that ought to bring ‘management enhancement’ to potentially interesting exploration properties.

8. Are the company’s principal properties in stable political environments friendly to mine development? If not, whether this results in enhanced risk needs to be considered.

9. Are the company’s properties close to existing transportation, utilities, and ore processing infrastructure? If not, whether this results in enhanced risk needs to be considered.

10. Does the company regularly issue Press Releases announcing consistently positive drill results? If not, whether this results in enhanced risk needs to be considered.

11. Are current stock prices significantly below recent trading prices – which is almost always the case in the mid-December, 2008 markets? If the current stock price is less than a recent financing price where institutional and other ‘sophisticated’ investors participated, and the company itself has experienced no material ‘negatives’ between the closing of the financing and the current date, one might consider what conclusions, if any, can be drawn from this.

12. Are Insiders buying or selling shares, and if they are, what conclusions if any can be drawn from this?

13. What percentage of the company’s outstanding shares do Directors and Officers own on one hand, and by Institutional Shareholders on the other? What conclusions if any can be drawn from this?

14. What is the daily average trading volume in the company’s shares? This is important in order to determine the likelihood of being able to liquidate your shareholding in a reasonably short period of time?

StockResearchPortal.com

1. In the context of gold mining stocks, StockResearchPortal.com facilitates screening for cash and debt on hand, daily average share trading volumes, Insider Trading, and much more through the Compare & Rank Companies and Company Research tabs found on its Main Navigation Bar.

Concluding Comments – Should One Own Gold Stocks?

1. Repeating what I set out in Post #10 in this Post Series: “Many commentators and ‘expert’s suggest that gold as an ‘asset class’ ought not to represent more than 10% of an investor’s portfolio, with not more than 5% in bullion and 5% in gold equities – i.e. stocks or funds (for example, see Goldwatcher – page 211). At least one, Shayne McGuire, says: “Considering present (2008) financial conditions, I would suggest holding eight to 15 percent of your financial assets in gold and I would not think it insane to hold as much as 50 percent. But just keep in mind that once you get over, say, 20 percent of your assets in gold you are expressing the conviction – with me – that gold will outperform other financial assets over the next few years, which is educated speculation.” (Buy Gold Now – page 152).

2. In Post #10 I stated in reference to gold bullion: “My own view is that we currently are living in extremely turbulent economic and geopolitically risky times, and that in these times investors ought to consider that the long-term broadly held view of owning up to 5% of one’s financial assets in the form of gold bullion presumably assumes more ‘normal economic and geopolitical conditions’ than currently exist. That leads me to think that one ought to seriously consider a somewhat higher percentage than 5% of one’s financial assets in physical gold – but how much, if any, physical gold held by any given investor has to be a function of each investor’s assessment of prospective economic and geopolitical conditions, and their individual risk tolerance.”

3. I would say the same thing with respect to shares in selected gold exploration and production companies – that is:

• depending on one’s tolerance for risk the current economic and geopolitical conditions;

• combined with the much reduced stock market prices for many such companies over the past few months,

currently (in mid-December, 2008) there may be good gold mining stock ‘buying opportunities’ to be found if detailed research is done. Having said that, I believe:

• One should not be influenced by the aforementioned ‘5% of one’s financial assets ought to be in gold mining stocks’. First, I am not one to adopt the ‘rules of thumb’ of others, and certainly would not adopt a ‘rule of thumb’ I believe to have been advocated during what I will describe as ‘broadly normal stock market conditions’. In mid-December, 2008 both economic and stock market conditions fairly can be said to be ‘far from normal’, which in my view in and of itself would negate the suggestion of an ‘up to 5% rule of thumb’ in either a negative or positive way depending on one’s point of view and risk tolerance.

• Only sophisticated and ‘mining knowledgeable’ investors, or investors who rely on sophisticated and ‘mining knowledgeable’ investment advisors, should invest in gold mining stocks in normal market conditions – let alone current market conditions where in my view they need to be ever more detailed in their research activities – and concurrently take more ‘personal ownership’ of their investment portfolios.

• Such sophisticated investors should only invest in gold mining stocks if they have access to serious research and due diligence data, study it, and be prepared to speak with the senior management of each company they consider investing in.

4. In summary, investing in gold mining shares can result in leverage, and sometimes significant leverage, to the physical gold price. Having said that, it is my view that only sophisticated investors who:

• their own opinion on the direction of the gold price at any given point in time;

• clearly understand the speculative nature of investing in gold mining shares, particularly companies that are explorers and not producers;

• have a working knowledge of the business models and various risks faced by gold mining explorers and producers alike; and,

• are prepared to do serious research and due diligence on the companies they believe are worth investing in

should consider investing in shares in gold mining explorers and producers.

For previously issued Posts in this Series click here.

The views expressed in this Post are those of the author. They are offered to readers for information and general guidance only. They are neither intended to, nor should be taken to, constitute economic or investment advice. See Legal Disclaimer.

© 2008, Stock Research DD Inc., all rights reserved.

Possibly Related Posts:

• The General Public, The Eurozone, and Gold!
• Gold as an Investment – How I Assess It and Why – Post #10 of 11
• Gold as an Investment – How I Assess It and Why – Post #9 of 11
• Gold as an Investment – How I Assess It and Why – Post #8 of 11
• Gold as an Investment – How I Assess It and Why – Post #7 of 11

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