As the gold and silver markets turn the corner and move back to the uptrend, mining companies are recovering quite nicely. Ahead of the 'credit crunch' in 2007, the common belief was that almost any mine was a good investment. Since then, many investors have learned a salutary lesson on the subject often seeing his investment fall to a level far below the price he paid.
Each investor has his favourite gold shares and may continue to believe his chosen vehicle will reward him the most. Nevertheless, it's good to review what a gold or silver share is and what principle should govern an investor's selection of shares over all other principles.
What are your investing objectives?
Each investor usually has an investment objective, whether it is short-term profit, capital gain, dividend flow or the broad concept of 'total return' (capital and income returns added together). Which one do you fall under?
The most successful investors have the advantage of being able to reinvest their income flow from investments getting the joys of compound returns. This means that they have invested with shareholders in mind. When looking at an investment, one has to define it carefully, particularly in gold, silver mining companies.
After all, a mine is not gold and silver; it's a derivative of the metals, in that it relies on the prices of both gold and silver for its success. But it remains a corporation run by fallible people facing many corporate risks. A great deal has to happen in this structure for the individual shareholder to benefit from the gold or silver prices.
Main Investment Principle
The first rule of investing in precious metal companies is to look for a company that is focussed on rewarding shareholders. This means that the cash flow they receive is targeted at paying dividends to shareholders. Some companies do this by formalizing an agreement to pay shareholders a percentage after tax cash flow. They also define what costs they will be spending their capital on, including exploration costs. As a shareholder you can relate your investment potential to gold and silver prices. Without this, how will you know the gold share will benefit from a rising gold price?
This was highlighted in the publication of Australian gold production in the December quarter. Remarkable on a low gold price, gold production had risen. At 74 tonnes, gold production was the highest it had been since June quarter of 2003. Why?
Gold producers are treating less low-grade material, which results in higher output and reduced costs. Lower prices forced a switch from lower grade ores to higher grade ores because of the need to maintain a particular level of profitability. The cut in reserves being seen among producers all over the world has the effect of shortening the life of the mine while production rises. Producers usually aim to maintain profitability, not necessarily to increase it. So if the gold price rises, we expect production to drop as miners return to lower grade material -this extends the life of the mine, but is it in the interests of shareholders? Of course not!
The days of pre-2007 -when shareholders were content to see mining company share rise in price--all long gone. The uncertainties of the financial world demand a specific return on the shareholders' capital employed. In other words, the investor needs to maintain a cash flow that justifies the capital value placed on their shares.
What's important to investors is that the companies behind the shares are not companies who extend the life of mines at the expense of shareholder cash flows.
Be Certain of Company Policies!
Gold and silver producers who link their profits to dividends irrevocably, reward shareholders. Investors should look for these companies. Such policies should be encapsulated in Mission Statements that define their approach to rewarding shareholders. A mining share will only reflect moves in the gold price, if the path to shareholder rewards is spelled out. If it isn't, then the link to gold is muddied, and risks are heightened.
Ideal Gold, Silver Producers for Investors
Of course, the gold company that keeps increasing the size of its gold reserves faster than it uses these to produce gold, is the one that extends its life no matter the gold, silver price. The rate of production is then defined by its capacity and ability to produce. This number divided into the reserves is what defines its life. This is the mining company to choose.