The performance of gold mining stocks is influenced by the underlying precious metal companies produce and sell. Therefore, the first factor to look at when investing in the gold mining industry is the price of gold.
Since gold prices are influenced by the Federal Reserve’s decisions on interest rates, investors should closely follow monetary policy as an increase in interest rates can produce a bearish effect on the price of gold. The popular belief is a strong, negative correlation exists between interest rates and gold prices.
Furthermore, knowing the exposure of gold stocks to changes in gold prices is very useful for investors. When gold is surging, they can open or increase their positions in gold stocks that are characterized as having a higher than average beta gold, which measures how volatile the stock is in relation to gold.
Another factor investors should take into consideration when investing in gold stocks is seasonality. There are periods of the year in which gold peaks. These periods correspond with the holiday seasons: the Christmas holidays, the Indian wedding season (which occurs at the end of the year) and between late spring and the beginning of summer as this is wedding season in Western countries.
Another factor investors should look at it is the volume a gold mining company can sell. Together with the price of the metal, volumes influence revenue and earnings for the quarter. Of course, the volume sold depends on production, which is influenced by a number of factors, including throughput, equipment maintenance, work-related accidents and weather conditions.
Investors should also look at the value of the dollar versus the local currencies of the countries in which miners operate. The economics of a miner that bases 50 to 60% of its total production outside North America will be impacted more by depreciation toward the local currencies than companies that localize their production in the U.S. because the first will report higher operating costs when translated into U.S. dollars.
The type of mine is also important to consider. A miner that extracts most of the gold it sells using underground techniques usually incurs higher operating costs than a miner that produces gold from open-pit or surface deposits.
The condition of machinery and the processing plant also have an impact on cost because the older they are, the more the company needs to spend on maintenance. These costs are usually booked as sustaining capital expenditures. The funds a mining company uses to upgrade its asset base are capitalized by spreading the expenditure’s cost over the asset’s useful life. This factor is very important since the mining industry is one of the most capital-intensive industries. Gold mining companies usually have considerable capital expenditures.
The final factor to be considered is the price of the metal assumed by the miner when determining its mineral reserves. This is the minimum price at which gold should trade so the company can gain a profit from mining its reserves.
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