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Ignore ETFs, Look at Gold Miners

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There is a misconception that the price of gold is driven solely by investor demand, but this is not the case. According to the World Gold Council in the second quarter of 2013, just 12% of gold demand came from investors. Thanks to strong interest from jewelry buyers and other actors, this precious metal will provide many investing opportunities over the next decade.

Look past the hype
It is natural that investors like to talk with other investors. For gold investors this holds a hidden danger. In the second quarter of 2013, ETFs and similar products saw outflows of 402 tonnes, equal to 47% of total net gold purchases for the quarter. Total investment demand was boosted by coin and gold bar purchases, leading to positive net investment demand, but strong ETF outflows leave the impression that the sky is falling. 

Total gold demand has taken a hit; as of the most recent quarter it is 17% under its five year average. Still, this 17% reduction is far less than the massive ETF outflows that have been seen recently. Even as many ETF investors fled the market, central banks, jewelry buyers, and the technology industry have helped to stabilize total demand. The gold market is multifaceted, and going forward the financial markets will just be one part of the demand equation.

Where to invest?
ETFs like the SPDR Gold Trust (NYSEMKT: GLD  ) are some of the most popular gold related securities. The problem is that these are a poor fit for the long-term investor. All the trust does is buy gold, lock it away in a room, and then offer you ownership of said gold.

SPDR Gold Trust is a good way to play short term price trends. For long-term investors looking for a dependable return on their investments, it is important to note that this trust pays no interest. In theory the price of gold will keep up with the rate of inflation and maintain the value of your investment, but this is not guaranteed. The below chart shows how starting in 1996, it took a full 10 years for the change in the price of gold in U.S. dollars per U.K. troy ounce to catch up with changes in the U.S. consumer price index.

UK Gold Price Chart

UK Gold Price data by YCharts

Gold miners 
Yamana Gold (NYSE: AUY  ) is a better way to grab a piece of the gold market. The company has already declared its third quarter $0.065 dividend, providing income for investors. It has a number of mines in Brazil, Mexico and Chile. Its Brazilian Pilar mine just came online, and this will help to boost the company's production in the coming years. The company's balance sheet is clean with a small total debt-to-equity ratio of 0.11.

A very important metric to look at is the firm's all in sustaining cash cost. This number shows just how much the company pays to keep its operations going, thus giving you a good idea its ability to endure market volatility. Including by-products, it has all in sustaining cash costs of $916 per gold equivalent ounce in the second quarter of 2013. With gold prices currently in the $1,300 per ounce to $1,400 per ounce range, the company has comfortable margins. This makes its dividend relatively secure, and helps to ensure that it will have enough cash flow to fund capital expenditures. 

Goldcorp (NYSE: GG  ) is another gold miner, but its margins and costs make it a second rate investment compared to Yamana. While Yamana had all in sustaining costs of $916 per gold equivalent ounce in the most recent quarter, Goldcorp had all in sustaining costs of $1,279 per gold equivalent ounce in the same period. The company is looking to cut costs across the board and bring its all in sustaining costs down to the $1,000 per ounce to $1,100 per ounce range in 2013, but it will still be above Yamana. 

On the plus side, Goldcorp realizes that lower gold prices may be the norm in the short term. It recently took a writedown on its Mexican Penasquito mine, but its debt load is reasonable with a total debt-to-equity ratio of 0.11. Its high all in sustaining costs make its dividend more risky than Yamana's, however.

Demand for gold jewelry, coins, and bars is quite strong. Gold's recent price decline has spooked many investors, but other buyers have come up to the table. In the long run people continue to buy gold, and with a strong miner like Yamana you can make a relatively stable investment in the sector. Goldcorp is another company to consider, but for now its higher all in sustaining cash costs means that is safer to stick with Yamana. 

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Related Tickers

8/29/2016 1:46 PM
AUY $4.55 Up +0.13 +2.94%
Yamana Gold CAPS Rating: ***
GG $16.42 Up +0.47 +2.97%
Goldcorp CAPS Rating: ***
GLD $126.40 Up +0.35 +0.28%
SPDR Gold Trust CAPS Rating: **