Gold vs gold miners Gold

goldNick Barisheff
For thousands of years, gold has been used as money, a store of wealth, fought over and sought after. Over the last 45 years, Western populations have had a mixed impression of gold. A minority of the population understands that gold is a monetary asset that should be held as wealth insurance. A larger percentage of the population is confused about gold because of mainstream sources of information. Many people consider gold a risky investment when in fact gold bullion is not an investment at all, but rather money itself.

Just like any fiat currency held in a vault, gold does not pay interest or dividends. Investors often look upon gold mining companies in the same light as physical gold bullion. Gold mining shares are investments, and can be good tactical investments from time to time. However, the characteristics of gold bullion and gold miners are very different. In some ways, those differences are similar to the difference between an insurance policy and shares of an insurance company.

It is important to understand the role of gold as money in relation to fiat currency. Governments and banks work hard to ensure that people retain confidence in their debt-backed paper currencies, and in the economy in general.

Wall Street’s message about the economy and the US dollar’s strength has to remain optimistic, because when people are uncertain and sceptical, they do not invest in financial assets, and companies curtail new financings, creating a negative feedback loop. Financing is Wall Street’s lifeblood, so it will always see “green shoots” and “recoveries around the corner,” just as it did in 1929, 2000 and 2008 while the market crashed around it.

Consumer spending and bank lending is what keeps the fiat shell game going, and people do not borrow or spend when they feel uncertain about their financial future. Gold, because it inconveniently serves as the truest, irrefutable long-term indicator of the economy’s health, has to be discredited.

There are three essential characteristics of money: it must be a store of value; it must be accepted as a medium of exchange; and it must be a unit of account, meaning that it must be divisible and each unit must be equivalent.

Fiat currency has failed as a store of value, and it has no intrinsic worth. How much does it cost to type in zeros on a computer screen or on a piece of paper? Certainly less than it does to dig a mile into the earth to extract and refine two grams of gold from a tonne of rock.

The US Federal Reserve was created in 1913. From its creation through to this day, the US dollar has lost approximately 98,2 percent of its purchasing power. On the other hand, gold has retained its purchasing power, rising from $20,64 an ounce in 1913 to $1,250 an ounce today. Throughout the ages, whether it be in Roman times, in 1913 or today, one ounce of gold has provided a man with a pair of shoes, a suit and a briefcase, or the equivalent.

A popular misconception about gold and gold miners being similar has to do with the symbiotic relationship between the two. Mining companies have claims to, or outright ownership of, gold that is in the earth. The gold resources need to be extracted, processed and then sold to cover the costs of operations for the company to make a profit. Gold in the ground is very different than a gold coin that can easily be transferred from a seller to a buyer.

Mining companies are dependent on the price of bullion in relation to fiat currencies. Specifically, if gold is too low in price, a mining company is unable to extract the gold from the ground, because it is uneconomical. Subsequently the value of the mining company’s shares will trade at lower levels, or the company could go bankrupt. The higher the price of gold, the more economical it becomes to dig for lower-grade sources of gold.

Mining shares can move up significantly as gold moves higher, but that is not always the case. Below is a chart of the HUI Gold Miner Index, which contains the top unhedged gold producers in the world, compared to the performance of gold bullion. While the miners performed well from 2003 to 2007, over the past 20 years the Index shows a loss of 13,9 percent, whereas gold is up 233 percent.

The 1970s provide a good example of how gold and gold miners perform during inflationary time periods. In the late 1960s, Lyndon Johnson’s government was escalating the war in Vietnam and increasing government-backed social benefits. This caused the US government to run ever-increasing budget deficits.

Prior to 1971, the US dollar, as the world’s reserve currency, was tied to gold bullion at US$35 per ounce of gold. Many countries started to redeem their US-dollar reserves for physical gold bullion. The amount of gold being delivered was unsustainable, and in 1971 Richard Nixon closed the “Gold Window,” eliminating the ability of countries to exchange their US dollars for gold.

Inflation spiked as the United States increased its sovereign debt load by funding unsustainable government outlays. By 1980, gold had reached US$850 per ounce. Gold adjusted to the changing environment, and increased in price in relation to the faltering US dollar.

It’s interesting to see that gold bullion virtually doubled the return of Homestake Mining Company (the largest gold miner in the world at that time). This is another example of the difference between gold bullion and gold mining shares. From a risk perspective, there are major divergences between physical gold bullion and shares of gold miners. – Resource-investor.

Nick Barisheff is president and CEO of Bullion Management Group Inc., a bullion investment company that provides investors with a cost-effective, convenient way to purchase and store physical bullion. Widely recognised in North America as a bullion expert, Barisheff is an author, speaker and financial commentator on bullion and current market trends.

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