Burning The Candle At Both Ends

Candle burning at both endsI was frustrated. I need solid, safe income. The bank bailouts will eventually cause high inflation. Interest rates were not keeping up. Investors, desperate for income, had few choices and the stock market was setting records. How do you invest, earn safe income while protecting your capital and buying power all at the same time?

I asked that question in every booth I visited at the Money Show. No one addressed my concerns – they just hawked their particular investment products as the magic pill.

When I asked, “What about gold?” I generally heard, “It provides no income” or, “It’s too risky!”

Brokers don’t want you investing in gold, they can’t earn fees from it. When I asked about gold stocks, they looked at me like an escapee from a leper colony.

With historic government debt and unfunded liabilities, there is no way the government can tax or grow their way out of debt. No wonder readers are concerned about inflation.

We have recently discussed how gold, foreign currencies, and stocks performed during the high inflation Carter years.

Gold stocks can help, if you know what you are doing. Most stockbrokers don’t have a clue and are not interested.

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I contacted former colleague, and member of our panel of experts, Jeff Clark, senior precious metals editor at GoldSilver.com. When it comes to gold, he is our go-to expert.

DENNIS: Jeff, thank you for helping to educate our readers.

In the past we discussed physical gold as the best alternative for combating inflation. The downside is it provides no income.

Today I want to discuss gold stocks. Readers should understand there is a big difference between an explorer looking for the mother lode and a large mining company.

Investors need reasonable risks that provide both income and inflation protection, particularly if it spikes.

Jeff when you look at gold stocks, how do you categorize them?

JEFF: Thanks for inviting me, Dennis. I used to work as a mining analyst, so this is a fun topic for me.

It’s critical to own gold, but if an investor wants to take an additional step to hedge against a significant rise in inflation, gold equities have historically offered that.

There is a vast range in the types of gold stocks and associated risks. Generally, the bigger the producer, the more stable and less risky the stock. Many pay dividends. They tend to have multiple mines around the world and produce 1 million ounces or more per year. You generally won’t see huge spikes in their share price, though they have historically responded to periods of high inflation.

Next are the mid-tier companies, producing less than one million ounces per year. These companies tend to see their share price react more to market-moving events – good or bad – than the large producers.

Following are the junior producers, who typically are defined by low output and/or one-mine operations.

Next up, the developers or pre-producers. They have found gold and are building a mine. They are riskier, because their projections may not be as accurate as they thought. Generally, they see a greater rise in their share price leading up to production since the company is moving from a developer to a producer.

Last are the pure exploration companies, those looking to find an economic deposit. These are pure speculations. I doubt you would recommend these companies to your readers who are trying to protect their life savings.

A unique category is royalty or stream companies. They lend money to a miner who needs funds to build a mine or explore a project and are paid a royalty once production begins. Established royalty companies usually pay a dividend to shareholders, and are generally a lower risk than a producer, since they’re not involved in running a mine.

DENNIS: OK, that makes sense. Let’s set aside the high-risk exploration companies and focus on the others. Is there any data available showing how the industries did during the Carter years?

JEFF: I can show you how the industry performed during that entire decade. The Barron’s Gold Mining Index consisted of established gold producers. This chart shows their performance vs. the S&P 500 as well as during recessions.

Gold Stocks Soared Chart

Gold stocks, as a group, dramatically outperformed both the general stock market and inflation.

This is important, for two reasons. One, the equity markets do not have to do well for gold stocks to perform well. While they can follow the general markets at times, they are much more likely to follow gold.

Two, they can perform well in times of economic/political distress, high-interest rates, and yes, runaway inflation. If you see any kind of turbulence ahead, especially if that includes a rise in inflation, gold stocks can offer an additional way to hedge that kind of environment.

Readers should understand that gold stocks have not kept up with inflation over the past 5+ years, even with dividends. We haven’t had high or rising inflation, so this isn’t surprising. If one expects inflation to pick up, history says gold equities are highly likely to outrun it.

DENNIS: I’ve owned a couple royalty companies for years. I use them to supplement my holdings in real gold and silver.

While I receive regular dividends, the prices of the underlying metals have more effect on the stock price than the current dividend. I look at them as an inflation insurance policy that is also providing some income. Does my idea make sense?

JEFF: As long as you use them to supplement your physical gold holdings, yes. They are still equities and come with the associated risks, and you do not have access to any physical gold.

For the investor who would like to follow your strategy, producers and royalty companies would be the first logical step. Not only can you collect a small dividend from most of these companies, the share price is like an option on gold – if gold is rising, they will generally rise more than gold, as well as inflation.

Your insurance analogy is close. Unlike a life insurance policy that has a specified payout, gold stocks tend to rise with the gold price. In a strong price environment, management teams are likely to increase the dividend as well.

DENNIS: When it comes to assessing capital appreciation/depreciation, inflation and dividend income do you have a preference between mining companies and royalty companies? If so, what do you prefer and why?

JEFF: I’ve made and lost money in both groups. The general consensus is royalty companies are probably the safest investment in this space. They have lower risks than a producer, and many have locked-in royalty payments for decades.

There is probably just as much upside in a royalty company as in a large producer while carrying less overall risk.

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DENNIS: How important is the political environment where the mine is located?

JEFF: I’m glad you asked; it is becoming an increasingly important factor to consider.

I invested in a company that discovered one of the largest gold deposits in a decade – but the host government got so greedy with taxes and fees that the project sits idle to this day. My investment suffered greatly. You can’t move a mine to a more favorable jurisdiction.

Environmental activists have also stopped or delayed many projects. In some cases, they have valid concerns while others were overblown. Lenders and big mining companies have become increasingly cautious about investing money in many jurisdictions.

DENNIS: One final question. If a reader wanted to hedge their bets with some gold stocks, what advice would you offer?

JEFF: I can offer three suggestions.

The simple way is to buy an index or a mutual fund. GDX is the Gold Miners ETF and consists mostly of producers. You get the bad with the good in an index, but the risk is lower than buying an individual stock. GDX pays a small annual dividend.

For more active management, my recommendation would be Tocqueville Gold Fund (TGLDX). I know one of the portfolio managers personally, and I can tell you he assigns gold the same importance that you and I do.

A second option is to look for a newsletter that specializes in gold stocks in the category you have interest. Many newsletters focus on the explorers or pre-producers. Those are high risk/high reward opportunities. Each niche is a specialized field and analysts who understand the nuances can be very valuable.

Last, I’ll mention that my most recent presentation included stock picks. This focuses on why I think both silver and select silver equities have a huge upside potential. In full disclosure, I own everything I recommend. However, I don’t offer a service, so the investor won’t know when I sell – or if I buy more.

I believe gold and silver will enter a new bull market in the near future. Adding gold equities is another way to potentially hedge against rising inflation, as well as collect some income along the way.

Gold stocks are significantly undervalued to gold right now, so they offer much better value than common stocks. Summer is typically a weak period for precious metals, so could be a good time to enter this market.

Dennis, thanks again for allowing me to talk to your readers.

Dennis here. We have been looking for ways to hedge against inflation and still earn some type of income. Supplementing your gold holdings with stocks is another tool to use – in moderation. I’m comfortable with our investment in royalty companies.

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On The Lighter Side

I recently wrote about how banks have changed the rules of the Monopoly game. Former colleague Ed Steer writes a daily newsletter, Ed Steer’s Gold and Silver Digest, which I highly recommend. He published the article and added an interesting graphic, and gave me permission to pass it along.

That sums things up pretty well.

And finally…

Good friend Bob O. provides this week’s humor titled “Adult Truths”:

  • Sometimes I’ll look down at my watch 3 consecutive times and still not know what time it is.
  • Nothing sucks more than that moment during an argument when you realize you’re wrong.
  • Bad decisions make good stories.
  • I disagree with Kay Jewelers. I would bet on any given Friday or Saturday night more kisses begin with Bud Light than Kay.

And my favorite…

  • I love the sense of camaraderie when an entire line of cars team up to prevent a jerk from cutting in at the front. Stay strong, brothers and sisters!

Until next time…

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