One of the primary keys to success in investment and speculation is picking the right stocks to trade. That’s no mean feat, as it takes great effort, expertise, and time to winnow the whole field down to the likely winners with the best fundamentals. Although deeply out of favor now in the summer doldrums, the small contrarian gold-stock sector has generated truly epic gains for investors and speculators over the years.

The primary mission of my research has always been to drive profitable real-world trading. If financial-market research doesn’t actually help multiply wealth, why even bother? The stock trades resulting from these 17 years of hard work were all recommended in real-time in our newsletters as the buys and sells were actually made. Our cumulative realized stock-trade count is now up to 357 in our monthly and 571 in our weekly.

928 real-world stock trades fully disclosed to, fully accountable to, and fully auditable by our subscribers over such a long span of time has been an unparalleled learning experience. Like all speculators we won some and lost some, but our overall track record is outstanding. All 928 Zeal newsletter stock trades ever closed, including all losers, have averaged impressive annualized realized gains of +22.0% since 2001!

Since our first newsletter was published on August 1st, 2000, the compound annual rate of return of the benchmark S&P 500 has only been 3.1%. The S&P 500’s absolute return over that long intervening secular span is 67.6%. But 22.0% compounded annually since then equates to a radically-better 2903.4% return. There’s no doubt that studied stock picking and trade timing can vastly outperform the indexes!

Since general stocks have mostly been mired in a secular bear since early 2000, the great majority of our Zeal trades have been gold stocks and silver stocks. The precious metals are one of the best-performing sectors during sideways-grinding general stock markets. So one of the most common questions I get is how do I go about picking great gold stocks? What factors do I consider in trying to sort the best from the chaff?

These are tough questions to answer. So much time on task, so many trades, so much experience both winning huge profits and suffering vexing losing streaks are challenging to distill down into a book, let alone an essay. It’s hard to even know where to start after tens of thousands of hours of research on markets and individual stocks. Nevertheless, I get this question so often that I should at least attempt to address it.

So here’s a brief overview of key things I look at when comparing and contrasting gold stocks attempting to find fundamentally-superior ones to trade. And “gold stocks” used in this essay applies equally to silver stocks. My stock-picking methodology is a perpetual work in progress. I’m always learning and striving to improve it, and there are plenty of traders out there with long track records better than mine.

Major-ETF Inclusion. Ask any prospector where the best place to find gold is, and he’ll say where it has already been found! Great gold stocks are very similar. So one of the first things I check when I’m researching individual stocks is what ETFs they are included in. The companies creating the leading exchange-traded funds and the indexes behind them have big research departments full of experienced analysts.

The dominant leading gold-miner, gold-junior, and silver-miner ETFs today are GDX, GDXJ, and SIL. They are the VanEck Vectors Gold Miners ETF, the VanEck Vectors Junior Gold Miners ETF, and the Global X Silver Miners ETF. Being considered worthy of inclusion in these elite ETFs truly is the gold standard in precious-metals stocks. So if a miner or explorer is large enough, I always check for ETF inclusion.

I certainly don’t only trade gold stocks included in major ETFs, but when one is I know it has been vetted by leading expert researchers. While some of the stocks they include perplex me, the majority are truly the best in the business. ETF inclusion can be a self-fulfilling prophecy too. Since most investors and speculators settle with ETFs these days instead of individual stocks, their ETF buying drives up components’ prices.

Market Capitalization. If I had to decide on a single-most-important factor for picking great gold stocks, I’d actually choose market capitalization. That may sound shocking, as how could market cap be even more important than production, costs, or reserves? The reason is market caps ultimately distill everything that all traders collectively know about any gold stocks, and govern their potential for big near-future gains.

When buying a house, the first thing you have to consider is price. It makes no sense to fall in love with a perfect house you simply can’t afford. Gold stocks’ market capitalizations, especially when they are considered relative to each other, give great insights into how valuable their mines and projects actually are. Market caps are the ultimate form of relative ranking resulting from actual real buy-sell votes from all traders!

When two gold miners with similar production levels have significantly-different market caps, the one with the higher market-assigned value almost always has the superior fundamentals. Investigating why market-cap differences of similar producers have arisen is one of the more-rewarding parts of gold-stock picking. Market-cap premiums often reveal superior mines, projects, or managements than similar peers have.

Market capitalizations also greatly affect future gains. The higher the market cap of any stock, the more capital inflows and buying will be necessary to drive it significantly higher. Like oil supertankers, the larger gold stocks have big market-cap inertia and will ultimately see smaller gains than their smaller peers. On the other end of this spectrum, super-tiny gold stocks will often prove too illiquid and risky to trade.

When comparing all gold stocks by market cap, there is a sweet spot of small-but-not-tiny to mid-size gold miners that have the best potential to see the greatest gains in their stock prices assuming their fundamentals are sound. The higher market caps among this optimal gold-miner size usually have the most-superior fundamentals, but the lower-market-capped stocks will be easier for new buying to push higher.

Jurisdiction and Diversification. Unfortunately mining companies are exceptionally vulnerable to local government over-regulation, over-taxation, and even confiscation. Unlike most industries, gold mines’ production can’t be shifted across borders to flee to more-friendly countries. So I always look to see where gold stocks’ mining operations and major exploration projects are located. Some countries are too risky for me.

Mexico and Canada are probably the best countries in the world to mine gold in. Their mining laws are well-established and their governments generally don’t harass miners too much. The US is safe, but over-regulation and ludicrously-onerous permitting processes make America somewhat less attractive. Plenty of countries in South America, Asia, and even Africa are fine, but property rights and rule of law are less certain.

But some countries often ruled by Marxist dictators have ugly histories of forcing gold miners into paying punitive taxes and royalties under the implicit threat of mine seizures. Like much of stock picking, that knowledge simply comes from experience. We’ve owned gold miners in the past that have suffered major predation by local governments, so it makes no sense to buy other miners with heavy exposure to them.

This great geopolitical risk inherent in static gold mining can be diversified through mines and projects spread across multiple jurisdictions. Smaller gold stocks only have one mine or project, so diversification is impossible. But larger ones have multiple mines and projects reducing the threat posed by any one government. Cross-country diversification does add significant costs as well though, it can be a double-edged sword.

Production. Gold stocks are naturally in the business of mining gold, so their current and projected production levels from mine expansions or new mines coming online are exceedingly important. The more gold companies produce, the greater their operating cash flows, profits, and therefore ultimately stock-price gains. But with larger operations also come bigger market caps, weighing down upside potential.

Within that sweet spot of smaller-to-mid-size gold miners, I like to compare miners’ production relative to their market caps. While this ratio means little in isolation, considered across a group of miners it helps reveal which are relatively expensive or cheap. As long as those miners with lower market caps per ounce produced have sound fundamentals, they often have greater upside potential than their more-popular peers.

Production trends are also important to consider. If a gold miner’s production is moderating or retreating for anything beyond a well-telegraphed few-quarter span, it suggests depleting mines and lower coming stock prices. Sometimes gold miners have good reason for lower production, such as planned digging through lower-grade ore to get to higher-grade ore or temporary disruptions due to mine-expansion projects.

Growing production is viewed highly favorably by traders and portends higher stock prices, so miners with consistent output growth are prized. Managements often provide guidance early every year for their coming annual production, making it easy to find expected growth. Big growth surges driven by new mines coming online are often great opportunities to see fast stock-price appreciation around their openings.

Since it’s far easier to simply consider reported current-quarter production instead of wading through quarterly filings, annual reports, and news releases to get updates on new mines nearing production, many investors overlook new-mine openings. Gold stocks often see major gains in the year or so that straddles new mines spinning up to commercial production, from about 3 quarters before to 1 quarter after.

A high-potential subset of this phenomenon occurs when explorers successfully manage to make that rare transition from explorer to producer. Since gold deposits now take 10 to 15 years to prove out, permit, and construct mines, most traders lose interest long before these plans come to fruition. So finding an explorer on the verge of opening its first mine in the next year or so can be a major upside opportunity.

Costs. Gold miners naturally have no control over the price of gold, their selling price is set by the whims of global gold traders. And gold-mining cash flows and profitability are totally determined by the difference between prevailing gold prices and miners’ costs. So gold miners’ cost levels are the critical driver along with the gold price of their operating cash flows and earnings. Costs drive profits leverage to gold.

Comparing gold miners’ costs, especially all-in sustaining costs, helps determine the better ones to buy. And that isn’t as simple as low costs are good and high costs are bad. Lower costs are great if gold is expected to go lower, as it makes for fundamentally-stronger miners generating more cash flow and thus better able to withstand gold corrections or bear markets. Low-cost miners are bid to premiums on weak gold.

While I prefer lower-cost miners since I like fundamentally-strong gold stocks, higher costs actually have greater upside profits leverage to gold-price increases! So if you expect a major gold bull or strong gold upleg, higher-cost miners actually have more upside potential. This seemingly-counterintuitive outcome is easy to understand with a simple example. Consider two hypothetical gold miners, LowCost and HighCost.

LowCost produces gold at AISC of $600 per ounce, so at $1200 gold it’s earning hefty operating profits of $600 per ounce. Meanwhile HighCost’s AISC are $1100, so its profits are far smaller at just $100. If gold powers 67% higher to $2000 in a major bull, LowCost’s profits more than double from $600 to $1400. But those 133% earnings gains are dwarfed by HighCost’s soaring from $100 to $900, a vast 800% rocketing!

Since stock prices ultimately reflect underlying corporate profits, higher-cost miners have much greater upside potential in a gold bull than their fundamentally-stronger lower-cost peers. Bigger profits growth equals bigger stock-price gains. So don’t avoid owning a gold stock simply because its costs are higher than its peers, as long as they’re still low enough to weather a major gold selloff. Costs are critical for profits.

Financials. Gold-mining costs directly feed another major factor to consider, gold miners’ financials. Cash flows generated from operations are important to analyze when picking great gold stocks. They are usually a better indication of gold miners’ fundamental strength than accounting earnings since the latter can be obscured by noncash writedowns or gains. Strong operating cash flows eventually drive strong profits.

I also always look at gold miners’ cash on hand, and debt levels and debt service. Just like with any individual, the more cash a gold miner has in the bank the easier it’s able to weather any unforeseen adverse shocks. They could be a gold selloff, a mine-production problem, or government harassment. Higher cash balances also position gold miners to expand existing mines or buy new deposits and mines.

While gold miners generally finance major mine builds with equity instead of debt, debt levels and quarterly payments relative to operating cash flows are also important to consider. While it’s rare to find gold miners with hefty debt payments compared to cash flows, I avoid them. Debt can point to another major potential problem, hedging. Banks often require gold miners to hedge production to secure a big loan.

Hedging, locking in the future selling price for gold produced, is highly undesirable. Investors buy gold stocks because they want leveraged upside exposure to gold-price advances, and hedging sells away that future upside! Hedging is a big black mark against a gold miner in my book, although I will still buy companies that hedge if their hedging is a small percentage of their production required for a mine-build loan.

Reserves. While gold reserves are important since they are necessary for gold miners to maintain their production, many investors overweight them. Proving up gold resources to reserves is very expensive, requiring big drilling and assaying campaigns. So as long as miners have sufficient reserves for the next couple years or so, it’s usually not beneficial to shareholders to spend capital to aggressively grow reserves.

Large reserves are more common in open-pit operations, where ore bodies are close to the surface and relatively easy to drill. Since the ore grades are so low in open-pit heap-leach mining, companies often market the value of their deposits in terms of their large reserves. But underground high-grade mines often only have a year or two of reported reserves because drilling too far ahead slows actual mining progress.

Dividing reserves by the current annual production gives an estimate of mine life. While more reserves granting a longer mining life make a company stronger fundamentally, they aren’t a major consideration for picking great gold stocks. In many ways the length of time gold miners have been producing, which shows their experience and longevity, is more important than showing off a massive reserves number.

Management. Managements’ track records are very important. Like in any industry, the longer that a management team has been running gold mines the more experience it has. And that eventually leads to success much of the time. So I consider what top managers have accomplished in the past, even if it was at another mining company. Proven battle-tested people are far more likely to produce excellent results!

For stock-price appreciation, managements’ ability to manage investors’ expectations conservatively is important. Management teams that consistently under-promise and over-deliver are far less likely to spook traders into selling en masse. So how managements perform on actual production and project advancement compared to the expectations they set in press releases is certainly worth considering.

Those press releases themselves also reveal much about how managements view and respect their shareholders. Great gold miners publish very-transparent quarterly results, full of numbers and year-over-year comparisons easy to parse visually. That builds trust. But I’ve seen far too many gold miners release quarterly results that are devoid of much important information. I always wonder if they’re hiding something.

While all companies naturally try to present their news and operating results in the best-possible light, deep data is always available from their quarterly filings with government regulators. So obscuring it through fact-light or poorly-presented news releases might fool a casual investor, but it won’t stop a real analyst from finding the truth in 10-Qs or 10-Ks. Managements being opaque can be a major warning sign.

Market Timing and Technicals. No matter how great gold miners’ fundamentals happen to be, they are all dependent on gold to see major stock-price moves. It’s relatively rare to see even great gold stocks power higher if gold strength isn’t lending them a bid. After all my years trading this sector, I suspect something way up around 80% of gold stocks’ price behavior is driven by the gold price action over any span analyzed!

While the fundamentally-superior gold miners will usually outperform in any given gold rally, they really do need gold to climb to enjoy major gains. So picking great gold stocks in a vacuum oblivious to the big market trends dominating their performance is an exercise in futility. While I’m constantly researching to understand individual gold stocks’ fundamentals, I try and wait to buy positions until gold is likely to advance.

Technicals are a critical consideration in picking great gold stocks too. Buying high is rarely wise no matter how awesome any gold miner may be. If a stock has just rallied dramatically, chances are it is due to mean revert and retreat a bit. But if a stock has just plunged, it is probably due for a big mean-reversion rebound. The best time to buy great gold stocks with superior fundamentals is right after they sell off!

When I make new trades, I usually narrow down my buy list to twice as many gold and silver stocks as I’m actually planning on buying. Since they all have great fundamentals after being sifted out of the gold-stock universe using the considerations above, I’ll often attempt to buy low by adding positions in the particular gold miners out of my finalists with the weakest technicals. Buying low is absolutely crucial!

Naturally that means gold-stock pullbacks and corrections driven by similar moves in gold are the best times to add gold stocks within ongoing bull markets. And the upside potential at those lows is dwarfed by that at major secular lows like January 2016’s. If you are buying gold stocks when they’re high and you’re excited, that’s the wrong time. The best time to buy is when they have just sold off and you are nervous!

Well, these are some basics of picking great gold stocks. I like to feed as many gold stocks as I can find into big spreadsheets, fill them with data on each company, and sort them based on all the things discussed here and other lesser considerations. Like any endeavor of learning, the more time you spend deeply immersed in gold stocks the better you will understand them and the easier it will become to pick the winners.

Realize that most investors and speculators simply don’t have the time, interest, training, necessary skillset, or temperament to put in the vast hours required to gain the knowledge and experience essential to excelling in trading any particular sector. So for most traders, it’s far more efficient to hire experts to do this hard work for them. The most-cost-effective way to benefit from expert analysis is through newsletters.

The bottom line is picking great gold stocks requires a lot of work. Many factors feed into the process of separating the likely elite winners with the best fundamentals from the average rest of the herd. There are no shortcuts, it’s a long painstaking process to learn about individual gold stocks and compare them with each other. But the resulting fruits are awesome, lower-risk trades with superior upside potential.

And it’s not just one thing that makes a great gold-stock pick, but the interplay of many things. Fitting all these puzzle pieces together to feed profitable trades is an art that only comes through years of actual real-world trading experience. If you have the time and mindset to develop this skillset, you’ll be richly rewarded by the markets. But if you don’t, piggybacking off the research from established experts is the way to go.

By Adam Hamilton