There are many ways to gain exposure to movements in the commodities, including precious metals. One of them is mining stocks, i.e. shares in mining companies.Mining stocks can be divided into two broad categories: seniors and juniors. The former are stocks of a considerably large commodity producing mining companies with an established position and relatively large market capitalization, while the latter are stocks of smaller mining companies with little capital and short history. For these reasons, juniors are more risky than seniors.
The mining stocks are often seen as a more convenient way of gaining exposure to the given commodity than holding physical metal. For example, without having to own any bullion, investors can benefit from rally in the gold prices, since usually when the price of gold rises, the profits of the gold mining company also grow.
Moreover, mining stocks usually offer leverage, as the commodities can be mined at prices lower than the spot price (however, this is not always the case and we invite you to check leverage of most important gold stocks and silver stocks using our investment tools).
Gold Stocks and Gold
Although there is a strong link between the commodity prices and mining stocks, the relationship is not linear. Actually, the stocks’ sensitivity to commodity prices varies over time and across companies. You see: some companies hedge themselves against fluctuations in the price of metal they mine, while other producers may not extract anything yet.
Moreover, investors should also remember that purchasing mining stocks is not an investment in a particular commodity, but in a company digging bullion out of the earth. It implies that a position in equities may not always track changes in commodity prices due to company-specific factors (like mismanagement or labor union strikes) or crashes in the stock market.
One way to avoid the problem of selecting the promising shares is to invest in many of them, for instance replicating one of the indices. The two most watched indices of gold mining stocks are the NYSE Arca Gold BUGS (Basket of Unhedged Gold Stocks) Index (called the HUI Index) and Philadelphia Gold and Silver Index (called the XAU Index). The chart below compares the historical performance of these indices against gold.
Chart 1: The price of gold (yellow line, left axis, London P.M. Fix), the HUI Index (green line, right axis), and the XAU Index (red line, right axis) from 1996 to 2016.
Mining stocks is one way of gaining exposure to movements in the price of commodities the company mine. However, it is not a perfect play on gold or other metals. Although the correlation is high, an investment in miner’s equity is a whole different kettle of fish. In case of gold, the stocks are not a safe haven against market turmoil, but a bet on company’s operating earnings and the management team which controls it. Therefore, investors should remember that although in theory mining stocks provide a leveraged way to own exposure to movements in commodity prices, in reality many miners lag behind the physical market. This is for example why investment in gold shares is very demanding and the key is to pick the appropriate gold stocks.