December 20, 2010 - The steady climb of gold bullion prices has hucksters crawling out of the woodwork with schemes to make even more money off of the bull market. One of the more heavily promoted products lately are gold mine stocks, which are touted to multiply increasing gold prices.
The argument goes like this: Average production cost for an ounce of gold in the third quarter of 2010 was $585, so gold bullion purchased at $1200 per ounce produced a gross profit of $615. When gold reached $1400 per ounce, a 16% increase, the gross profit rose to $815, a 32% gain assuming mining costs remain constant. Thus the net worth of the mine based on its in-ground reserves also rose 32%. The profit multiplying effect has some validity, but only up to a point and it is not nearly so dramatic. And of course, losses will be multiplied the same as gains.
Gold mines are vastly different from manufacturing and retailing operations. The only basis for evaluating a mine’s worth is the extent of its reserves, and that can be known for certain only when the mine plays out. Unexpected technical difficulties are frequent and can be very expensive, cutting deeply into profits. Furthermore, operating expenses often based on local currencies while output is independent, making profitability potentially volatile and difficult to assess. In addition, the location of many mines can result in incompetent management and make them subject to government instability.
Mining operations are funded based on highly optimistic forecasts of lifetime yield and conservative estimates of the movement in gold prices. That combination dilutes the “multiplying effect” and greatly increase the possibility of overvaluation when investment is heavy.
By far the best way to capitalize on rising gold bullion prices is the direct way – buying gold bullion.
