Recently by Jeff Clark: Competition for the IMF's Gold?
Jerrys broker wrinkled his nose in disapproval.
I dont like it, Jerry, he said in a grave tone, as if scolding a misbehaving child. Why dont you invest in the gold company I told you about?
Jerry thought this might happen. His broker was traditional, conventional, and only pushed company products. And the man knew embarrassingly little about gold stocks.
Because I want to diversify my gold stocks. Theres a lot of gold around the world. And this company is capitalizing on that.
The broker was shaking his head. The company I recommend is right here in North America, Jerry. Theres no need to buy one with mines halfway around the world. Besides, we dont know what the politics are over there.
Disappointed with the mainstream advice, Jerry left and called another broker. This one specialized in resource stocks.
Jerry explained his reasoning for wanting to buy this particular gold stock. The broker listened patiently, but was so quiet Jerry thought maybe he was cool on the idea.
Politics in general are somewhat unpredictable there, but less so for mining, the broker explained. In fact, they just lowered their tax rate on mining companies. The company hes recommending is well run, but its already a mature producer with a huge market cap, and has no exposure to these other parts of the world youre looking at.
Jerry felt comfortable with his original hunch after finishing his discussion with the new broker. He put some of his money into the stock of the younger gold producer, with assets on the other side of the globe.
A year later, Jerry ran into his old broker at a local bar. The man smirked when he spotted Jerry. He was obviously unhappy about losing Jerrys account and apparently wanted to rub it in.
You shouldve bought that gold stock I recommended last year, the broker said smugly. Its up 43%.
Good for you, Jerry replied, But that stock I told you about is up 75%.
The brokers smile wilted, and confusion clouded his expression. He spoke tentatively, not sure he wanted to hear the answer. Howd you know to look at companies there?
Lots of reasons, Jerry replied. But for starters, theres lots of gold over there.
Gold Around the Globe
The keyword is geographical diversification. And while no single investment variable can guarantee profits, geographical diversification does add a layer of safety and enhanced profit potential that investing solely in companies located in one country or region cannot offer. Jerrys broker, like many in the U.S. who dont know much about the gold industry, is uncomfortable investing in smaller producers or in faraway regions. And yet, most of the gold is currently being dug up in Africa, South America, China, and Oceania. North America accounts for only 16.3% of total gold production.
Further, of the 15 largest gold deposits in the world, only five are in the U.S., Canada, or Mexico. Many countries where gold has been traditionally mined, such as South Africa and the U.S., are experiencing production declines, while other areas, like South America and China, are just now starting to rev up.
First Step to Geographical Diversification: Make sure you have global exposure. If youre only investing in companies that have deposits where you have cell phone coverage, youre greatly limiting your profit potential. Dont ignore a region just because its an unfamiliar culture or doesnt speak your language.
Can We Tax That?
Dont get me started on politicians and NGOs [Non-Governmental Organizations] monkey-wrenching the free markets wheels. Hey, I want mining companies to keep cyanide out of the drinking water and for local communities to see some economic benefits as much as the next guy. In point of fact, most modern mining efforts run clean operations and provide good-paying jobs to local residents. But more often than not, greed is the motivation behind the politics governments want revenue, and mining companies can be an easy target.
As gold and silver mining-stock investors, it is imperative we understand and monitor the politics of any region where our companies operate. And not just the federal or provincial authorities; we must be alert to local community sentiment towards mining as well. Just because federal or state regulations are supportive doesnt prevent a local group from agitating against a development.
And laws affecting miners can change at any time, and suddenly, making the political climate tricky to judge and planning for mining companies and investors difficult. Would it be safe for me to assume, for example, that your tax planning of 10 years ago has had to be modified? The same applies with mining.
A stable political jurisdiction today can be tomorrows iffy hotbed of discontent. For example, the U.S. is consistently rated one of the lowest-risk countries in Resource Stocks yearly World Risk Survey. Yet, Washington politicians have drafted a bill that, if passed, would adversely affect mining in the U.S. While nothing is imminent, and we dont expect it would pass in its current form, we cant say that mining in the U.S. will never have any risk, and it is something we have to keep an eye on at all times.
On the other hand, eight of the worlds 10 highest-risk jurisdictions are in Africa, where Randgold has all of its operations. However, they mostly operate in countries where the politics are more stable, reducing their political risk to a tolerable and more predictable level.
The lesson: we cannot make assumptions about politics and mining based on geography.
So whats the solution?
Second Step to Geographical Diversification: Dont be overexposed to any single government. In todays political climate, and for the foreseeable future, there is no such thing as a 100% risk-free country. Politicians and political whims come and go, so risk will always be fluid. And we think gold mining could become an increasingly attractive target as the gold price rises and international economies struggle.
Of course, there are areas wed simply avoid. Of the 15 largest gold deposits mentioned above, we wouldnt consider investing in six of them solely because of the host countrys politics. We want diversification but not at the expense of unnecessary risk.
The One-Company Rule
Okay, perfect politics is a fairytale, so is there a way to minimize a downdraft in your portfolio if a government makes a negative move against one of your companys mines, or mining in general?
Third Step to Geographical Diversification: Own a sufficient number of companies. Having several eggs in many baskets will prevent your portfolio from suffering a Humpty Dumpty event if the government where your mining stocks are concentrated decides to follow, for example, Venezuelas lead. Country risk can be offset with the right mix of stocks. Thats why we dont just buy Barrick and say, Were diversified!
So… is your gold stock portfolio globalized? Do you have too much exposure to any one government? And do you own enough gold stocks so that bad news with any one company doesnt sink your portfolio?
The easiest way to diversify, of course, is to buy a mutual fund (see the table below for our top picks). But we think the mining stocks with the greatest profit potential are those newer producers with operations in regions seeing increasing production and greater exploration prospects.
Buy low, sell high is easier said than done. Is there a particularly good time to buy gold? Are there patterns in golds market fluctuations? Find out everything you need to know in our FREE Special Report How Do I Know When to Buy? Click here to read it right now.
May 12, 2010
Jeff Clark is editor of Casey's Gold & Resource Report in Casey’s Daily Dispatch.