We’ve already discussed why commodities are so damn cheap. Now we are going to address why you need to own mining stocks and not just physical silver and gold.
In this article and video I discuss:
- The leading indicator of a precious metals bull market;
- The advantages of own stock in a mining company vs. physical bullion;
- The downsides to physical metals and ETFs;
- Why not all miners are created equal; and
- How much money can you really make?
See the video here:
The Signal for a Precious Metals Bull Market
Today, the gold to silver ratio is higher than it has been since 1968 (as far back as my data goes). The ratio is over 100:1, meaning that you can buy more than 100 ounces of silver with one ounce of gold.
A ratio above 80 exceeds the 90th percentile of the historic data, indicating that silver is extremely undervalued.
Because 50% of annual silver production is used for manufacturing, the metal indicates when deflationary cycles are coming to an end by showing when relative valuation reaches extreme levels. This manufacturing component makes the price of silver more volatile than gold in bull markets.
The other 50% of global silver production goes towards demand as a store of value, which makes the ratio to gold all the more comparable.
Below is a visualization of the last three bull markets in precious metals overlaid with the gold to silver ratio.
How to Buy Silver & Gold?
There are several ways to benefit from a precious metals bull market. The first way is to simply buy bullion, which typically takes the form of gold or silver coins and bars. The benefit of owning physical metal is that you know exactly what you have and it can be traded as needed. The downside is that you will most likely pay a premium due to the costs associated with shipping, protecting, and storing your precious bullion.
To make matters worse it’s difficult to buy physical bullion today unless you are willing to buy a gold bar worth roughly $600,000. Smaller denominations are experiencing shortages due to supply shutdowns and mass demand in the midst of Covid-19.
Another way to invest in precious metals is to buy a gold or silver ETF. This is much easier than buying physical gold and provides exposure to the price swings of the underlying metal.
Precious metals ETFs are based on gold or silver derivative contracts such as futures, so you never actually hold the gold you buy, even in the event that the ETF is liquidated. Another drawback to ETFs is that you’ll likely end up paying management fees.
Lastly, you can do what I do, and buy mining stocks. In a bull market there is no better way to play precious metals than owning stock in a well-run mining company with great assets.
Mining stocks are just as easy to buy or sell as an ETF, but offer much greater upside potential. You can own part of a company that is producing hundreds of thousands of ounces a year and potentially has millions of ounces in the ground, or is on the cusp of making a new discovery.
This provides you with leverage.
Leverage is a financial strategy where you borrow money to increase your risk, but also return potential, in an investment. In this case, the mining companies are the ones who have borrowed and investors own a share of that company.
When precious metal prices are falling, you own a share of the debt and operating costs, meaning that you will likely lose more money than if you simply owned the physical commodity.
But, in a bull market (like we are experiencing today)…
You own a share of the profits from production and the ounces still in the ground. In this scenario the company’s leverage will give you access to higher returns compared to the price of the underlying commodity.
Now let’s compare the performance of mining stocks to silver and gold prices during recent precious metals bull markets.
A Recent History of Outperformance
Period 1: May ‘03 – March ‘08
First, let’s look at the 5-year precious metals bull run of the early 2000’s following the tech bubble. Silver returned investors over 330% during this period, but the investors with the biggest wins were those that invested in silver miners.
Below is a chart showing a handful of silver companies compared to the price of silver (in black). Many miners returned investors more than 500%.
MAG Silver returned investors over 2,500% during the period, and over 3,000% at its peak.
A similar scenario can be seen in the gold sector.
It’s important to note that many miners underperformed, this was due to many mining companies placing hedges against falling gold prices. They’d done this for several years prior to the bull market in an attempt to protect shareholders from the depressed prices, but at the end of the day it came back to haunt them, and cripple their share price.
Even still Newcrest Mining delivered nearly 500% returns, compared to 192% gold price returns.
Period 2: November ‘08 – April ‘11
During the 3-year precious metals bull market following the Global Financial Crisis, silver once again outperformed gold, returning ~400% and 100% respectively. During this period, Wheaton Precious Metals returned investors over 1,400%, while many other companies returned over 700%.
Gold miners showed investors more than double the returns made on physical gold.
While investing in mining companies you can deliver multiples to investors not all companies are created equal.
Only companies with high quality assets led by capable teams deliver truly excellent returns. The rest are just a flash in the pan.
If you want to see how we manage our own capital, and the gold mining companies that I’m investing in, check out Resource Insider and sign-up for our free email list here.
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