A Beginner’s Guide to Investing in Precious Metals
Precious metals, like gold and silver, have not only held value throughout history, being used as a currency, but have also found uses in many different applications today within different fields such as medicine and technology. Today, gold and silver, among other precious metals and natural resources, are classified as commodities, raw materials that can be bought and sold.
When it comes to investing, gold and silver are the two main precious metals. Gold is one of the most commonly invested precious metals, not as affected by supply and demand as others like silver or platinum simply because of the sheer amount of “hoarded” physical gold. Gold has some industrial applications in dentistry and electronics, but its main use is in jewelry and as currency. Today, investors buy gold mainly as a hedge against political unrest and inflation, and to diversify their portfolios. On the other hand, silver is widely used in batteries and various other industrial applications, making it more affected by supply and demand. Ultimately, gold should maintain its value more than other investments when purchased as a physical asset. “To put it simply,” says Investopedia, “when hoarders feel like selling, the price drops. When they want to buy, new supply is quickly absorbed and gold prices are driven higher.”
There are 5 main ways to invest in gold and silver: bullion, ETFs, royalties, exploration stocks, and mining stocks.
A practical, low-risk option for investors is gold and silver bullion. Bullion is high quality (>99.5%) physical gold or silver, often in the form of bars, ingots, or coins. This type of investment allows the owner of gold or silver bullion the ability to physically touch and see their purchase, providing more control over the investment. Buying bullion is a direct investment in the value of the commodity, and each dollar change in the price of gold or silver will proportionally change the value of one’s investment.
One downside to owning gold or silver bullion is that the physical asset requires secure storage or insurance. Some bullion investors store their metal in a bank vault or with another third party, while purists prefer self-custody, advocating, “If you can’t touch it, you don’t own it.” Bullion can also be more difficult to sell quickly at full market value, making it more of a risk when liquidating physical assets.
Compared to gold, silver is more volatile, less liquid, and more vulnerable to economic recession due to its importance in industrial applications. A popular way to buy silver is to purchase collectible coins; in the United States, coins made before 1964 contain about 90% silver.
Of the world’s total mined gold, approximately 20% is held by central banks, where bullion is held in reserves. Most bullion banks are members of the London Bullion Market Association (LBMA), including Bank of Nova Scotia, Citibank, JPMorgan Chase & Co., Morgan Stanley, Royal Bank of Canada, Goldman Sachs, Bank of Montreal, and more. Central banks can lend gold to bullion banks in return for the cash equivalent, which is then lent on the market at the Gold Forward Offered Rate (GOFO). Bullion banks can then sell the gold on the spot market or lend it to mining companies to finance projects.
Exchange-traded funds, or ETFs, provide investors with an alternative to purchasing physical gold and silver while still providing access to the bullion market. Some of these ETFs track the price of gold and silver, whereas others hold a basket of exploration and/or mining company stocks. As well as being easier to purchase and maintain, ETFs also provide investors with a more liquid approach to precious metals investing since they remove the factor of having to sell physical gold or silver. However, ETFs may offer less security than physical commodities when it comes to financial crises brought on by recession or war. Additionally, there is risk associated with the basket of instruments an ETF holds which may be individual companies or derivative securities. Top ETFs for precious metals investing include the Aberdeen Standard Physical Gold Shares ETF (SGOL) and GraniteShares Gold Trust (BAR).
A gold royalty is a contract between a mining company and a royalty company for the right to a percentage of production or revenue in exchange for an upfront payment. Royalty companies use these contracts to finance mining companies in need of cash and this method of financing can be more attractive than traditional debt or issuing equity. Royalties generally cover the life of a mine, so royalty companies benefit from any exploration upside that may extend the life of the mine and thus increase their profits at no additional cost. Rather than investing directly in mining companies, which poses a certain amount of risk, investors who put their assets into royalties gain access to a wider portfolio of investments.
The two most common kinds of royalties are net smelter returns (NSR) and net profits interest (NPI). An NSR is the agreed-upon fraction of net revenue that the royalty owner receives from the sale of the mine’s gold production, not including transportation and refining costs. The royalty is paid in variable or fixed payments based on sales revenue received by a mining operator in return for mining output, contingent only on the sales price and quantity of product sold.
The second type of royalty, an NPI, allows the royalty holder a share in the profits of the gold mine and so only comes into effect if and when a mine becomes profitable. Gold royalty companies often offer investment options in already-producing mining companies, giving investors an opportunity for a more immediate return on their investments. Gold royalty companies also tend to hold a portfolio of different royalty contracts, thus potentially giving investors diverse exposure to the industry with a lower level of risk.
4. Exploration Stocks
Gold exploration investing generally involves purchasing junior mining stocks, and holds more risk than bullion, ETFs, and royalties. For the average investor looking for exposure to precious metals, sticking with a lower-risk option, like an ETF, is usually the best play. However, for those with the time and risk-tolerance, gold or silver exploration stocks could potentially offer a very lucrative return.
Exploration or “junior” mining companies range from those just starting out with no meaningful discoveries, often referred to as “grassroots” explorers, to companies with meaningful discoveries, backed up by drill results, indicating a more promising future should they go into production. The road from exploration to production can vary, with some companies opting to enter production themselves, and others instead seeking to be bought out by larger organizations with the resources to begin mining the gold.
There are three outcomes for an exploration-stage company, and these should be kept in mind when looking to invest:
- First, the company may have enough early success that a major mining company sees its potential and purchases the deposit or the exploration company itself;
- Second, is that exploration-stage companies have the potential to fail, either from a lack of capital or because the deposit did not pan out as expected;
- The third outcome is when an exploration company discovers a large deposit of a highly-sought-after precious metal, leading to extremely high returns in a short amount of time for investors.
As an investor, it is very important to understand not only the current discoveries a company may have, but also how they plan to advance production in the future. An understanding of basic geology, along with mining terminology and financial statements, is a key aspect of being an effective investor in this sector. Some other factors to keep in mind when looking to invest in an exploration company are the management’s track record, a strong capital structure, support from others in the mining community (e.g. larger mining companies or major investors), and growth potential. In addition, connecting with an investor relations representative for a company you are considering investing in can shed light on additional details that can drive your final decision.
5. Mining Stocks
Investing in mining companies is one way to gain exposure to gold and silver, and can be more straightforward for beginner investors than purchasing physical gold while offering the potential for a greater return. Mining companies, unlike exploration-stage companies, have already made one or more discoveries and have an operating mine in or about to go into production. Therefore, they pose less risk than exploration-stage companies. The growth and return in the stock depend on the expected future earnings of the company, in addition to the value of gold or silver at the time.
Investors looking into mining companies should keep in mind that it takes a significant amount of cash to develop and run a mine. If you are interested in investing in a mining company, you want to look for one that has a decent amount of cash on the balance sheet as well as a low amount of debt. “Keep in mind, though,” says Forbes, “that the shares of stock of gold companies are correlated with gold prices but also are based on fundamentals related to each company’s current profitability and expenses.”
As with investing in exploration stocks, a lot of time and effort is required to research various aspects of the company and do proper due diligence. Management team, production costs, proven and probable reserves, project development, expansion potential, and jurisdiction are just some of the factors to take into consideration. For those new to the industry, we recommend taking as much time as possible in educating yourself before looking at individual companies and making an investment decision. Gold and silver miners with economically mineable deposits, effective management and solid financials can bring good returns, but a prudent investment in this sector will require research above and beyond what is required to analyze a typical stock. As with investing in exploration companies, connecting with an investor relations representative of the company can shed light on additional details that can drive your final decision.
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