When Gold is Savaged, How do I Choose a Gold Stock?

By: Julian D. W. Phillips | Wed, Oct 29, 2008
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Gold stocks have under-performed on the way up for the gold price and have been slaughtered on the way down. Is the day of the gold equity over or is there a way to select a gold stock and profit in such a market?

This essay looks at the long-term criteria for selecting gold shares. The mind set for the successful long-term gold equity owner has to recognize that gold shines in uncertainty and doubts about the future. So to get the best out of that situation one has to select a share that does well in poor conditions for equities. A share that can perform well in bear market will perform well in a bull market too. More importantly, a share that performs well in both in the long-term is usually far better than any other investment one can have. And there are some gold shares that have outperformed others by a huge margin. What do they have that others don't?

For 30 years a culture of invest in a rosy future has been the guiding light for the selection of all equities in the form of an "earnings don't count" culture, where the focus has been on present and future capital growth of a company. Well gold has risen because the future lost its rosy hue and the dark clouds of uncertainty appeared on the horizon. This tells fund managers, who dominate the tide and current of the share markets, that they should adjust the basis for share selection. In selecting a share they have to define the threats to share price appreciation. What are these?

  1. Increasing political uncertainty. In developing countries increasing taxes and royalties have and will impact profitability as government attitudes to mining changed from welcoming those who benefited the nation to resenting the profits made by companies from their assets. Sadly underground assets are worthless until they are mined, but greed eventually surfaces when profits for hard work are seen. An investor must select a company that mines in countries where the first attitude persists and will persist. If it changes then one should disinvest.

  2. Pricing in uncertainty and falling confidence. Paradise may come, but why pay a price that expects it? With the very high P/E ratios we saw in the markets, far too high expectations were priced in so they had to come down. For those who only paid prices that foresaw a dim future their dividend stream more than compensates for the rosy capital gain of the bright future and if the right price was paid, in burgeoning bull markets prices may rise so high that a sale with a view to re-buying on the fall will give intermediate capital gains? To pay too high a price will leave the dividend-flow hopelessly low. So buy at prices that allow for a good dividend flow. Right now share prices can reflect such prospects!

  3. Measure potential dividend flow levels in the light of 'risk free' investments such as Treasuries. If you can get 3.7% on Treasuries then in around three years you would hope that the total dividend you receive in that period will equal the total of three years Treasuries income [11.1%] and rising thereafter. This describes the days we have now moved into, days when you must see an income return on your money, one where bright hopes for the future are not part of the decision making formula. After all gold shines in bad times!

  4. How can one find a share which will see rising dividends?

    • The gold mining company must have sufficient reserves to last the long term and preferably shallow in the ground.

    • A policy and competence to continue to grow reserves so that if the gold price remains static, cash flow will grow.

    • The ability to control costs to the extent that profitability is not eroded through rising costs. It has to be said that in the climate most favorable for gold, costs will run up. But a rising gold price is usually eroded by rising costs. Therefore the company profile should evidence an ability to retain profitability in the face of rising costs. This secures the ability to pay rising dividends.

    • A sound well funded balance sheet, with low debt or zero debt.

    • Competent management with a sound record of performance.

    • A policy of dividend rewards for shareholders.

So when choosing a gold share consider:

If the gold share provides a rising dividend flow it will justify your investment in bear markets and pay for itself. In a bull market you will see capital appreciation of an extraordinary nature. In good and bad times such an investment will take care of your wealth.

We must emphasize that the dividend flow is the foundation of one's investment selection. If dividends are not there, or are just a hope, then the share has not and will not perform well. The gold shares that are performing well, are paying their shareholders and justifying why they should continue to hold them, in the face of those oh, so safe, Treasuries.

But remember, gold shares are equity investments, they are not gold itself. Therefore they have to meet equity criteria!

This is a snippet from the recent issue of the weekly newsletter from: www.GoldForecaster.com.

For the entire report, please visit www.GoldForecaster.com.



Julian  D. W. Phillips

Author: Julian D. W. Phillips

Julian D. W. Phillips
Gold Forecaster

Julian D. W. Phillips

"Global Watch: The Gold Forecaster" covers the global gold market. It specializes in Central Bank Sales and details, the Indian Bullion market [supported by a leading Indian Bullion professional], the South African markets [+ Gold shares shares] plus the currencies of gold producers [ Euro, U.S. $, Yen, C$, A$, and the South African Rand]. Its aim is to synthesise all the influential gold price factors across the globe, so as to truly understand the global reasons behind the gold price.

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