How to pick gold stocks that outperform the market

One of my favorite methods for discovering unheralded gold mining stocks is browsing through the holdings of large gold investment funds to see what stocks they’re gobbling up.

1) Don’t bet the farm on a junior mining stock. When you first start learning about investing in gold mining stocks, you’ll hear these phrases tossed around a lot: junior, mid-tiers and majors. The major gold and silver producers are the Exxon Mobils of the industry. Companies like Barrick Gold Corporation (NYSE:ABX), Goldcorp (NYSE:GG) and Newmont Mining Corporation (NYSE:NEM), for instance, all have market caps north of $30 billion. They’ve got numerous projects already producing gold and dozens of other projects and partnerships in the works. If gold prices collapse, they should weather the storm better than smaller, more speculative stocks.

Below the majors, you’ve got mid-tier companies that have brought at least one mine online or are very close to pouring gold with gobs of cash reserves in the bank and proven reserves in the ground. A promising mine in a politically stable country is as good as money in the bank for a lot of mid-tier miners as they’re solid buyout targets for the majors.

Below the mid-tiers, you’ve got juniors. They’re the small, thinly-funded, living-on-prayer-type companies (typically with market caps less than $2 billion) that buy up interests in large tracts of land, then start the long process of assaying the land for provable reserves. Know that when you’re investing in juniors, you could lose money just as easily as you could make it. The results of pre-feasibility studies can make or break a company – and you want to make sure you’re not broken along with a risky stock. Mix your gold stock holdings between majors, mid-tiers and juniors.

2) Make sure the execs have top-notch resumes. If you’re going to pour your cash into an unproven gold stock, take the time to find out who’s running the company. Almost all mining stocks have web sites touting the experience of the company’s employees and directors. Ideally, those managers, board members and geologists should have long track records with experience at major or mid-tier mining companies. There should be more than a handful of employees on the payroll, too. Some sites recommend only investing in companies with at least 10 employees.

3) Pay attention to the numbers. Kenneth J. Gerbino at Gold-Speculator offers some guidelines when it comes to evaluating just how great that new mining discovery is. A mine with less than 2 million reserve ounces, he argues, is likely not worth the investment it will cost to mine it (although, keep in mind, Gerbino wrote those numbers in 2009 when gold was much cheaper). When it comes to mines, bigger is better. Ten million tonnes at an open pit gold mine sounds large, but it’s not. Three-hundred million tonnes is large. Each of those tonnes should yield at least 1 gram of gold (or, better yet, 2 grams).

4) Location is everything. Look for gold mining stocks that are located near old or existing gold mines to lower your risk and increase the probability that your pick will hit pay dirt. It’s not without reason that much of the mining activity in the world happens in just a few locations. Special geological conditions are required for the formation of gold, and those conditions occurred in a relatively small number of places around the world. China, South Africa and Australia currently produce more gold than anywhere else in the world (although the U.S. and Russia aren’t far behind).

5) Follow the mutual funds. One of my favorite methods for discovering unheralded gold mining stocks is browsing through the holdings of large gold investment funds. See which stocks large gold funds like Tocqueville’s Gold Fund, Oppenheimer’s Gold & Special Minerals Fund, Midas Funds and others are holding. If they initiate a large new position in a relatively unknown gold mining stocks, chances are, you can hop on for the ride.



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