Investing in gold stocks can be risky. Mining for gold is expensive, and cash flow gets crimped if mines shut down or production expenses go over budget. Often, gold miners operate in parts of the world with unstable governments, and labor disputes are common, too. Even worse, projects can fail to pan out altogether. Finally, profitability depends significantly on gold prices, which can fluctuate for any number of reasons.
Nevertheless, there are reasons why investors might want to consider adding gold mining stocks to their portfolios in 2018. Gold stocks can provide investors a healthy dose of diversification, which may come in handy following the market's multiyear run-up, and because global gold supply is limited, they can benefit if global economic expansion causes inflation.
If these reasons have you interested in adding gold mining stocks to your portfolio, a few top companies to consider are Barrick Gold (NYSE: ABX), Randgold Resources (NASDAQ: GOLD), Newmont Mining (NYSE: NEM), Freeport McMoran (NYSE: FCX) and Goldcorp (NYSE: GG). All five could benefit if gold prices rally, so let's learn more about them.
Owning gold stocks for diversification
Owning uncorrelated investments -- or two or more investments that move in opposite directions in the event of a market correction -- is one way that investors diversify their investment portfolios against the risk of a stock market sell-off.
Finding uncorrelated types of investments has become harder to do since the Great Recession because some asset classes, such as bonds and stocks, are moving more in lock-step than they did in the past. Precious metal stocks continue to be relatively weakly correlated to stocks, however, and that suggests they may still offer investment portfolios protection if the stock market declines.
As a refresher, when two or more investment types move in unison, they have a 1.00 correlation, and when two or more investments move in the exact opposite direction, they have a -1.00 correlation. A correlation of zero means that two or more investments are uncorrelated and thus, they trade independently of each other.
How uncorrelated assets can work for you
Since 2004, the correlation between the SPDR S&P 500 ETF (NYSEMKT: SPY) and the SPDR Gold Trust ETF (NYSEMKT: GLD) -- a fund that pools together investors money to buy physical gold -- is only 0.33.
This relatively weak correlation suggests gold prices won't necessarily follow in the footsteps of the stock market. For example, when the S&P 500 lost nearly 37% of its value in 2008, the SPDR Gold ETF rose by almost 5%.
The correlation between the S&P 500 and individual gold mining stocks also suggests that they may not trade up or down with the stock market.
Although the capital-intensive nature of gold mining means that gold mining stock prices are more volatile than physical gold, many gold mining stocks offer a weak negative correlation to the S&P 500 that could benefit investors during a stock market tumble.
|Correlation to the SPDR S&P 500 ETF (SPY)
|Barrick Gold Corp.
|Freeport McMoran Inc.
|Newmont Mining Corp.
Having said that, the correlations between two or more investment types should be taken with a grain of salt. Correlations can change, particularly over short periods, and thus, gold mining stocks could lose money even if the stock market is falling.
Instead of relying solely on correlation, it's best to recognize that gold and gold mining stocks have a history of trading independently of the stock market and then, focus your attention on considering the pros and cons of each gold mining company to determine which stock is the best one to buy.
Profit from peak gold
Gold mining companies can mine for more gold, but ultimately, there's only so much gold in the ground. As a result, the amount of gold that a company has in reserves is important in determining if a gold mining stock is worth owning long-term.
One of the best ways to evaluate a gold miners reserves is to consider if its reserves are growing at a pace that's equal to or greater than the pace of the company's gold production. Companies that can find gold faster than they can mine gold are likely to have the best shot at profiting from peak gold -- the point at which gold production plateaus before drifting lower because gold is getting harder to find.
As of December 31, Barrick Gold is the world's biggest gold miner by production and its proven and probable gold reserves totaled 64.4 million ounces.
As a reminder, proven and probable reserves is an industry classification. It reflects reserves that companies have determined they can mine based on various factors, including geology, sampling, economics, politics, and other factors.
Barrick Gold's proven and probable reserves were down from 2016, but adjusting for assets it divested, Barrick Gold's reserves actually increased by 8 million ounces thanks to increased sampling via drilling. The increase in reserves from its continuing operations outpaced its 5.32 million ounces of gold production in 2017.
Freeport McMoran is primarily a copper miner (copper accounts for about 75% of its top line revenue), but since gold is often found alongside copper, it's still a top gold producer. Last year, the company produced 1.57 million ounces of gold, up from 1.09 million ounces in 2016, and its proven and probable reserves were 23.5 million ounces, down from 26.1 million ounces in 2016. Of its reserves, 23.2 million of its reserves are in Indonesia, however, and currently, Freeport McMoran's negotiating with the Indonesian government to continue operating there.
Randgold Resources' gold production increased 5% year-over-year to 1.315 million ounces in 2017 and its reserves slipped to 21 million ounces from 22 million ounces in 2016. Similarly, Newmont Mining's production grew 8% to 5.3 million ounces last year, yet it was able to keep its reserves steady at 68.5 million thanks to adding 4.4 million ounces to reserves from exploration and 2 million ounces to reserves because of revisions and acquisitions.
Finally, Goldcorp's goal is to boost its production by 20% to 3 million ounces by 2021, but right now, the trend is headed in the wrong direction. In 2017, its production was 2.569 million ounces -- down from 2.873 million ounces in 2016. It also wants to grow its reserves by 20%, and on that front, it appears to be in good shape. It came into 2018 with 53.5 million ounces, comfortably above the 50 million ounce target it set in January 2017.
Reserves only matter if companies can sell the gold they get out of the ground at a profit. Until recently, most gold companies reported expenses related to gold production as "cash costs." However, over the past few years, many have shifted to a metric referred to as all-in sustaining costs (AISC), which incorporates additional costs beyond typical production costs, such as corporate general and administrative costs, sustaining exploration and study costs, sustaining capitalized stripping and underground mine development, and sustaining capital expenditures, as well as other costs.
There are pros and cons associated with each of these approaches, but generally speaking, comparing AISC gives investors a good way to gauge which companies are best able to profit from rising gold prices. One caveat, though, is to make sure you compare apples to apples -- don't make the error of thinking AISC and other metrics are interchangeable.
Of these five gold mining stocks, Barrick Gold, Newmont Mining, and Goldcorp report AISC. Freeport McMoran reports total unit costs, and Randgold reports cash costs.
|Costs and profit (2017)
|Total unit cost
|% YoY Change
|Barrick Gold Corp.
|Freeport McMoran Inc.
|Newmont Mining Corp.
In 2017, Barrick Gold's AISC was the best of the bunch. The company's low costs were helped by operating leverage due to production expansion at key assets including Goldrush and Turquoise Ridge. Newmont Mining's $924 per ounce AISC was up 1% year over year and Goldcorp's AISC was $824 per ounce, down from $856 in 2016 and $894 in 2015.
Freeport McMoran's total unit cost for its gold production was $726 per ounce last year, yielding a gross profit of $541 per ounce. Companywide, its earnings climbed significantly, but that turnaround was largely driven by improving copper prices.
Finally, Randgold's total cash cost per ounce fell 3% to a six-year low of $620 last year, which helped its earnings grow by double digits.
Which of these companies is most profitable?
Since two of these companies report costs using different metrics, that's a little tricky to answer. Randgold CEO Mark Bristow has said in the past that using AISC opens the door to manipulation because companies can lower their AISC simply by cutting their planned exploration expenses. "We won't do all-in costs because that's just jiggery-pockery," Bristow said.
So, because there is a potential to game AISC, it may be best to consider it as only one of many puzzle pieces. Investors might also want to consider each company's operating margin. When you look at profitability in this way, you discover Randgold and Barrick have been the most consistent at dropping more of their revenue to the bottom line over the past three years.
What's the verdict
There are solid reasons to like Freeport McMoran, Newmont Mining, and Goldcorp, but among these gold mining stocks, my favorites to add to portfolios in 2018 are Barrick Gold and Randgold.
Freeport McMoran's focuses on copper, and copper prices are driven by construction and equipment demand, making it too heavily dependent on broad economic growth to win my vote as a gold stock to buy. The drag on Newmont Mining's bottom line from its high production costs can't be ignored. Goldcorp's plans to substantially increase production and reserves while reducing costs makes it intriguing, but there's no guarantee it will deliver on its goals, which makes buying its stock feel a bit risky to me.
By contrast, Barrick Gold is a production Goliath, yet its reserves still increased faster than its production last year, and it offers the second-highest operating margin of the bunch. Similarly, Randgold's production is climbing, its reserves are holding steady, and its operating margin is enviable.
Overall, gold mining stocks can play a valuable role in any portfolio. If they're interesting to you, then you might want to consider buying Barrick Gold and Randgold.
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Todd Campbell has no position in any of the stocks mentioned. His clients may have positions in the companies mentioned. The Motley Fool is short shares of SPDR S&P 500 and has the following options: short January 2019 $285 calls on SPDR S&P 500 and long January 2019 $255 puts on SPDR S&P 500. The Motley Fool has a disclosure policy.