All gold miners benefit from rising bullion prices, but some get a bigger boost than others. The real problem for investors is finding a miner in the precious metals industry that offers the right balance between risk and reward. A tiny, aggressive miner might triple in price as gold goes up but could end up a penny stock if prices go down. That is why investors looking to benefit from rising bullion prices should look at industry giant Newmont Mining Corp (NEM 1.43%).
A simple business model made complicated
At its core, gold mining is pretty simple to understand -- a company digs up the precious metal and sells it. It gets more difficult when you get into the details. For example, some mines are more productive than others. Mining costs generally go up as a mine ages. And some companies make extensive use of hedging to lock in gold prices. That can be beneficial at times but comes with risks.
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To give you an example of this, take a look at Harmony Gold (HMY 1.77%). Harmony's stock fell nearly 17% in June and is down around 25% so far this year. While shifting gold prices are a part of the reason for this, another important piece is that investors are worried about the company's hedges, which have begun to roll off and will continue to do so through at least the end of the year.
The impact of that is that Harmony will be forced to sell gold at lower and lower prices unless gold prices move above the floor of its hedges. And even if that happens, the hedges also end up capping just how much benefit it can receive on the upside. Hedging can be a good thing in some market environments, but it has its downsides. There's another option... don't bother hedging at all.
Harmony's hedges are rolling off. Image Source: Harmony Gold Mining Co.
Taking it as it comes
That's where Newmont comes in. In July 2007 Newmont made the decision to stop hedging its gold exposure and began selling gold at the spot price, no matter what that meant. Upon making the announcement, then CEO Richard O'Brien said, "With the elimination of our gold hedge book, we have renewed our commitment to maximizing gold price leverage for our shareholders."
So as gold prices go up, Newmont's results will head higher without any limits other than existing spot prices. And that makes it one of the gold companies with the most leverage to gold price advances. But what about the downside?
If gold prices fall, Newmont's results will head lower, too. After all, it has no hedges in place to protect itself from falling gold prices, which is where size and financial strength come into play. Newmont is one of the largest gold miners in the world and it has an investment grade credit rating of BBB from S&P.
In other words, if gold prices fall it has the scale and financial strength to survive. The best evidence of that, however, is the deep commodity declines seen after 2011. Newmont's shares fell as low as $18 a share (or so) -- relatively tiny Harmony watched its shares dip below $1 a share. Do you really have the fortitude to keep holding a stock as it plummets into penny stock territory?
Hedge your unhedged bets
If you are looking for a gold miner with the most exposure to gold prices you'll want to focus on a company that doesn't hedge. But there are risks in going without a hedging safety net, which is why you'll want to focus on large and financially strong miners that don't hedge. Newmont heads up that list. You could buy a tiny miner with high costs as a way to leverage yourself to rising bullion prices, but why take the risk when you can buy unhedged Newmont?
