A Diverse Approach to Gold

Nihar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With enough money you can diversify everything into little pieces, but for gold I have my own reasons for wanting diversity in how you expose yourself to the metal. I am surrounded by people who believe that gold is a one way trip. Clearly they do not remember 1980 or 1981, and neither do I, because it was a bit before my time. Then there is what happened to Spain with the discovery of the Americas, though a repetition of that will not happen unless we get smacked by a gold meteorite.

The Broad ETF Approach

There are lots of extremists when it comes to gold. They foresee complete disaster for the planet stretching from unsustainable policies. An anarchic collapse like that means those people should be buying water and non-perishable food. Temper your enthusiasm in gold by taking a diverse approach. I am not much of a gold bug, and I do not trust that metal at all. I use SPDR Gold (NYSEMKT: GLD) as a stand in for the price of gold since I do not trade commodities. The price of that ETF and gold diverges because some of the physical gold is sold regularly to pay the administrative expenses. Since it is a physical metal ETF there are no dividends or extra profits from a good trade.

I am a little ambivalent toward the ETF, but it can be a way to take a position in the physical metal without actually having to deal with a chunk of it. GLD has been trading in a tight range since mid-2011. Between $150 and around $170 has been the range for over a year now, and that does not really bode well in my opinion. Considering the enthusiasm surrounding the metal the range is disappointing. It is only one degree above a decline, considering the enthusiasm.

I think the weakness in gold will continue. The safe haven status does not hold up for the last year and a half. Bad news gets a little spike out of gold, but I think it is just from the expectation of some players in the market that people will allow fear to rule over them. However, news has not been uniformly good or bland for the last year and a half, and none of it has been enough to break past $170-$172. I would err on the side of caution with GLD. I in general do not like the metal, because of the mythic status it seems to hold for some people.

Large Miners: Safety and Profit

Gold is just shiny bauble dug up from the ground. I am simplifying, but overall the extraction of gold can be very cheap compared to its current high price. Just like with regular companies the huge ones tend to provide lower risk. It does not get much bigger than Barrick Gold (NYSE: ABX). The company has a market cap of $33B, which puts it right up there in the big leagues. In 2011, the company claims that it extracted gold for $460 in cash per ounce with a net cash cost of $339 per ounce.

There are a lot more factors that go into that so do not take those numbers as pure gospel. The company is not making three times or more its investment on every ounce. General overhead and the cost of mining rights and exploration are not generally included in the cost of physical extraction. Just like drug companies that invest a lot more into developing the drug than manufacturing a single pill.

There has been a pullback in the share price of the company, though it is still extremely profitable. I would want to see the dividend yield go up if the company cannot get its share price up. It might be too tied to gold's price to move on its own, even though it makes a profit off the metal and is not backed by it. Extraction costs are lower than the high price of the metal, and it would take an extreme fall to make ABX a bad investment. Don't be frightened by long term debt being so above cash, $14B versus $2.5B. Normally, I see that as a bad sign, but mining is capital intensive, and the company is cash positive.

Revenue and earnings growth measures would have me concerned, but that could be caused by the volatility in the price of gold. My yellow or red flag will be deteriorating margins, because that would signal to me that the company is not doing enough to control costs in light of declining prices for its output. For now all I have is a jumping off point for further consideration, I am uncertain about taking a position.

Junior Miners: Massive Potential, Big Risk

NovaGold Resources (NYSEMKT: NG) is an interesting junior miner. The company is low priced so if you like playing long-shots NovaGold is a good choice. I generally like to diversify high-risk, high-reward basically taking as many small long-shot positions if I am going to take any. It is almost like venture capital where you invest in highly risky assets, but you are looking for massive gains. NovaGold has a piece of Donlin Gold. Barrick is a partner in this project, but it has said the project will require a lot of initial expenditures and the process will take some time. Instead of pumping a ton of money into the project it will advance it at a modest pace.

NovaGold took it on the chin for that announcement. The company claims to have the cash to take the project to at least the end of the permitting phase, though there are more things to be finished before production is complete. There really are not a lot of fundamentals to focus on just the potential of the future. Barrick did not pull the plug they just signaled caution. You should too, but if there is space for speculation than consider it. 


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