Gold has been used as a currency since the dawn of human history. Though the precious metal itself is often cited as a way to resist inflation and provide a safe store of value, stocks associated with it can be much more dynamic.
Just how risky are gold stocks, and how closely are they correlated to the underlying price of the metal itself?
Differences Between Gold and Gold Stocks
The first important concept to understand when looking at gold stocks is their relation to actual gold.
Though gold prices certainly do play a role in the profitability of a stock engaged in mining the metal, other factors will ultimately affect how high a company’s earnings are and how fast they can grow. Due to this potential for earnings growth, gold mining stocks can produce significantly higher returns than gold itself.
Because mining companies are often well-established businesses with strong cash flows, gold stocks may also create income for investors through dividends in a way that physical gold doesn’t. Two of the top gold miners in the world, Newmont (NYSE:NEM) and Barrick Gold (NYSE:GOLD) pay dividends of 1.95% and 1.98%, respectively.
Though certainly not representing massive yields, these dividends can provide stable cash flow to shareholders, while physical gold would need to be liquidated to produce cash income.
Despite differences in potential return rates and the ability to produce dividends, there does tend to be a fairly high correlation between gold stock prices and the metal itself.
Over the past year, for example, gold has appreciated by about 31.0%. Shares of NEM are up about 31.6% over the same period, while shares of GOLD have lagged a bit at 26.7%.
On the other side of the equation, gold itself produces relatively modest growth most of the time and is illiquid compared to stocks in publicly traded companies.
Warren Buffett has famously illustrated gold’s poor investment performance when compared to the stock market by showing its weak returns against stocks like Berkshire Hathaway and indices like the Dow Jones Industrial Average over multi-decade periods of time.
The reason for gold’s comparatively weak returns is the fact that it is a non-productive asset. While stocks in businesses can continue to appreciate as those businesses grow and produce more earnings, the price of gold simply increases as investors become willing to pay more for it.
Though the price of gold marches steadily upward through the years, it does so at a much slower pace than stocks and other productive assets.
Where gold shines brightest is in its ability to ride out periods of economic instability. At times when stocks crater or stagnate due to macroeconomic factors, gold tends to retain its value.
In 2008, for example, gold closed the year at $869.75 per ounce. By the end of 2011, the price had risen to $1,531.00. This positive run for gold occurred amid the aftershocks of the global financial crisis and the onset of a weak, slow recovery.
Likewise, gold can be a safe store of value during periods of high inflation. In 1979 and 1980, for example, inflation ran at 11.3% and 13.6%, respectively. Gold prices rose by 120.6% in 1979 and 29.6% in 1980, staying sharply ahead of the general increase in prices brought on by inflation.
While gold lacks the liquidity and income potential of stocks, this ability to retain value in adverse market conditions accounts for much of the investor interest in the precious metal.
Are Physical Gold ETFs The Happy Medium?
Investors looking for exposure to gold with liquidity more akin to stocks may also be interested in physical gold ETFs.
These funds track the spot price of the precious metal by holding physical stores of gold. Though there will be minor variances, these funds closely mirror the ups and downs in the price of actual gold.
Because physical gold ETFs trade on public markets, they can be traded readily and don’t require investors to store physical gold in their own homes.
Beyond physical gold ETFs, investors can also buy shares in gold mining ETFs that track several mining companies in a diversified portfolio.
Like individual mining stocks, these ETFs typically pay dividends to their shareholders, making them more attractive than physical gold ETFs from an income perspective.
Buying mining ETFs may also be less risky than buying individual gold stocks, as investors are less exposed to the performance of any one mining company.
How Risky Is It To Buy Gold Stocks?
Buying gold stocks tends to be more risky than investing in the precious metal itself but they are not inherently especially risky investments.
Whether gold mining stocks or physical gold ETF shares, the risk involved in investing in publicly traded gold instruments appears fairly low. Though gold stocks may be more volatile than gold itself, they tend to be fairly stable.
Physical gold ETFs closely track gold prices but provide easier liquidity, making them both reasonably safe and a potentially convenient option for investors who want direct exposure to gold in their portfolios.
The risk that can come along with buying gold stocks is that of underperforming the market in the long run. Gold typically appreciates at a much lower rate than productive assets like stocks.
Though mining stocks can certainly solve some of this problem, they aren’t immune to gold’s tendency to undershoot overall market returns. Returning to Newmont, the stock has appreciated by about 56% in the past five years. The S&P 500, by contrast, is up 85.3% over the same period.
Ultimately, gold stocks may be good for some conservative investors hoping to achieve slow, steady growth or preserve their capital. For investors with a bit more risk tolerance focused on more rapid growth and wealth-building, however, they may not be able to provide sufficiently high returns.
Though gold stocks provide more liquidity and income potential than physical gold bullion, they often lag behind broad indices like the S&P 500. While gold stocks aren’t particularly risky in the traditional sense, their often modest return rates may not make them ideal assets for many investing strategies.
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