Gold stocks, meaning companies that mine gold or finance gold production, are currently out of favor.
It’s not a bad idea to add a little gold and/or gold stock exposure to your portfolio as a diversifier while it’s cheap, in my opinion.
This article takes a look at the role of gold stocks in a portfolio, and outlines two gold stocks for 2024 that I’m buying at the moment.
As a note, gold stocks can be a volatile group, and difficult to invest in. I generally think it’s a good idea for passive hands-off investors to have a small amount of gold exposure in a portfolio, but gold stocks themselves are best left to hands-on investors that don’t mind volatility.
Why Invest in Gold Stocks?
Over the long run, broad stock market indices tend to outperform gold and gold stocks by a lot.
Why? Because they are better at exponential compounding, with structural growth and dividend reinvestment. People who invest too heavily in gold all of the time tend to miss out on the biggest engines of wealth creation.
However, gold and gold stocks have historically been a great addition to a diversified portfolio, because there are certain environments where they absolutely crush normal stocks. Particularly, when stock markets become unusually expensive, they historically have underperformed gold over the following decade.
This chart shows the cyclically-adjusted earnings/price ratio of the S&P 500 in blue, and shows the 10-year annualized outperformance of the S&P 500 vs gold via the orange bars:
Chart Source: Lyn Alden (with data from Robert Shiller)
At current S&P 500 valuations, a century of data suggests that they are likely to underperform gold over the next ten years. Will that repeat for sure? No, and who knows. But among other things, it’s a variable that leads me to like having gold in my portfolio.
More broadly, having gold and gold stocks as a small part of a portfolio acts as a diversifier against currency weakness, stagflation, and economic instability.
As I wrote in my guide to precious metals investing:
The price of gold is affected by multiple things, with no perfect correlation to any one thing. However, real interest rates are one of the major inputs that can affect the price of gold.
The real interest rate is the difference between a safe investment like a Treasury bond, and inflation. During times of very low interest rates, the interest yields of premium saving accounts and Treasuries may be lower than inflation, meaning that people who are saving diligently are still losing purchasing power. In contrast, during periods of higher rates savers in those instruments may get a real return over inflation.
Gold is an ancient form of money, something that stores value over millennia by keeping up with inflation of fiat currencies, albeit with substantial volatility.
If savers have the option of holding gold that keeps up with inflation and maintains global purchasing power over the long term even in the event of a catastrophe, or holding fiat currency that is currently paying negative real interest rates (rates that don’t keep up with inflation, thereby losing purchasing power), then suddenly gold becomes quite appealing to store wealth in. Higher demand for gold can lead to higher gold prices.
On the other hand, if savers can get a decent real interest rate above inflation on their savings accounts and safe bonds, then the desirability of holding gold diminishes. Lower demand for gold can lead to lower gold prices.
Gold, however, is also impacted by volatility in the markets. When investors get scared, they often turn to gold and drive the price up. Therefore, while interest rates play a major role in gold valuation, they are far from the only variable involved.
Look at examples of financially troubled areas of the world like Argentina in 2018 or Turkey in 2021. Their currencies crashed hard in those years, but investors that held gold did quite well for themselves. Being diversified into assets outside of your home country’s currency, including gold, can help quite a bit during times like that.
Holding a small bit of gold in a portfolio is a safe hedge; something that is not very well correlated with stocks and bonds, and therefore historically helps smooth out total portfolio returns over the long-run.
Gold stocks are more aggressive. The power of them is that a small position, like 3% of a portfolio, could potentially go up 2x-3x or more in value during certain types of economic environments (especially stagflation), partially offsetting losses from a much larger portion of the portfolio invested in normal equities.
I like bitcoin as a diversifier as well, but it tends to shine at different moments than gold. Bitcoin historically does well when the economic growth is accelerating with tons of liquidity (such as measured by the purchasing manager’s index), including in 2011, 2013, 2017, and 2020. Gold, on the other hand, tends to hold its own more often when economic growth is decelerating, such as in 2019 and perhaps 2022.
The Problem with Gold Stocks
Although I like to own gold stocks at times, they come with a lot of risks.
Gold stocks have operational and financial leverage against the price of gold, which leads to more risk and volatility. When the price of gold goes up, good gold stocks typically go up even more. And when the price of gold goes down, both good and bad gold stocks tend to sink even lower.
Let’s say, for example, that the price of gold is $1,700 per ounce.
A gold company might be able to mine gold at a cost of $1,200 per ounce. Gold companies generally measure this by their all-in sustaining cost (AISC) per ounce. So in over-simplified terms for the purpose of example, they make $500 per ounce in profit at current prices.
If gold drops to $1,200 then their profit disappears. If gold goes up to $2,200 then their profit doubles to $1,000 per ounce, even though gold prices only increased by 29% from $1,700 to $2,200.
And then along the way, if governments seize their mines in emerging jurisdictions, or they have geological challenges with their mines, or labor strikes, or a sharp increase in input costs, then they eat the difference with their profit margin.
The very best gold stocks can outperform gold over the long run, because they are basically short dollars and long gold, and gold has historically gone up a lot compare to dollars. The amount of gold in the world increases by about 2% per year or less while the amount of dollars in the world increases by about 8% or so per year. Meanwhile, the top gold miners can pay dividends and compound wealth over the long run like other high-quality companies.
However, the majority of gold stocks underperform gold over the long run because they use destructive capital allocation practices and deal with all of these previously-mentioned operational risks. They make acquisitions, expand mines, and take out debt during the peak of bull markets when everything is expensive, and then capitulate in bear markets, destroying shareholder capital. They then repeat this cycle after cycle.
The smartest gold stock managers, which are few and far between, use a counter-cyclical approach whereby they add capital into bear markets and extract capital during bull runs. Even they, however, have risks for things outside of their control, like mine exploration results, the cost of energy, complex labor/government negotiations, and operational challenges.
The result is that gold miners as a group have underperformed gold itself by a wide margin:
So, for a permanent portfolio holding, gold itself is better than gold stocks.
Gold stocks are useful when you are particularly bullish on gold, and when you stick with the highest-quality companies or the best risk/reward speculations. The best time to buy them is typically when gold is unloved and leading indicators of the economy, such as the purchasing manger’s index, are rolling over.
In addition, there are signs of structural change among gold miners. They are being a lot more disciplined with capex and debt in this cycle, and instead are emphasizing free cash flow and strong balance sheets for the most part. That’s a promising sign.
The safest gold stocks have:
- Low debt
- Low AISC
- Large reserves
- Or a royalty/streaming model
Riskier gold stocks with high debt and/or high AISC have more to gain when gold prices go up a lot in a short period of time. This is because they are on the verge of insolvency when gold prices are low or moderate, and can be saved by high prices.
On the other hand, safer gold stocks with low debt and low AISC don’t jump quite as fiercely when gold goes up, but they survive better through the full market cycle if gold gets historically cheap.
2 Gold Stocks I’m Buying For 2024
Franco-Nevada (FNV)
Franco-Nevada is the global royalty and streaming leader. Rather than mine gold themselves, they provide capital to mine operators and are entitled to a stream or royalty of gold from that mine. The consistency of this capital-light and diversified model has allowed them to increase their dividend for 16 consecutive years.
And lately their share price is in the bargain bin.
Although Franco-Nevada is highly diversified, they do have a handful of large key assets that are disproportionally impactful for their revenue. Their large investment in the Cobre Panama copper mine has faced a set of major legal setbacks in recent months.
Chart Source: Franco-Nevada December 2023 Presentation
Although the stock is primarily a gold royalty/streamer (accounting for about two thirds of their revenue), they are also diversified into silver, oil, and other commodities as well. Their equity trades at high valuations, but that’s because they have no debt, plenty of cash, and run extremely high gross profit margins and revenue per employee, as most royalty and streaming companies do.
While it’s not without risks (as this recent Cobre Panama setback has shown), I’m a buyer of Franco-Nevada on weakness.
Agnico Eagle (AEM)
Agnico Eagle is one of the largest and most successful gold miners around today.
They’re not cheap relative to other miners, but that’s in large part because their mines are in safer jurisdictions. All of their geographic exposure is in North America, Mexico, Australia, and Finland.
Chart Source: Agnico Eagle November 2023 Presentation
The stock pays one of the higher dividend yields in the industry at nearly 3%, which is also nearly the high point for Agnico Eagle. The stock is trading rather cheaply compared to its operating cash flow and dividend payouts.
Generally speaking, gold miners trade at lower valuations than gold royalty companies, but have more operation and cost risks. For example, if energy prices (a major expense for gold miners) rise a lot more quickly than gold, then that can pressure the margins of gold miners but doesn’t really affect royalty companies.
Overall, I like a mix of both as a small slice in a diversified portfolio.
Independent Speculator Review
Many investors like to buy smaller natural resource exploration companies, including for gold and other commodities.
However, this is a very risky area and takes a lot of geological knowledge and deep due diligence on each company. As a macro investor and broad stock analyst, I don’t have the expertise to dive into individual gold, silver, oil, uranium, or copper projects, other than some of the biggest ones.
In other words, when I look at a commodity, I look mainly at the long-term macro case for that commodity, and then examine some of the biggest and safest ways to get exposure to it, or buy an index.
I often get questions from readers about if I recommend any gold/silver/resource analysts, since I don’t cover junior gold/silver/resource stocks myself. For years my answer was that I did not, because although there are some good ones out there, it’s known as a rather scammy industry, prone to sensationalism and bad performance.
However, I now recommend Independent Speculator, run by Louis James (Lobo Tiggre), for people that want to check out smaller and more exploration-focused natural resource plays. And for full disclosure, I added him to my affiliate partner list, which I use for services that I either personally use myself or that I’ve vetted and that I think cover areas well that I don’t focus on myself.
He has a clear track record, and is about as anti-hype and anti-sensationalist as one can be. He tends to focus on realistic expectations and risk management for his positions. I’ve been on his podcast twice, where I enjoyed discussing markets with him. He puts in the long hours to sort through individual small cap resource plays to find asymmetric opportunities for his clients.
If those sorts of targeted speculations are of interest to you as part of your diversified base of assets, then I recommend his work.