In Jim Cook's Archive



Mining stocks break down into three broad categories: big producers, small to medium producers and exploration companies. More often than not, investors own exploration companies, which they erroneously refer to as mining companies. In reality, these are companies looking for gold and silver. Most exploration companies have never made a significant discovery and never will, but they have hope. These companies can go up and down in price, along with gold and silver. However, at some point, most of them go out of business or become shell companies that eventually undergo a reverse split. They fail because most exploration companies eventually run out of money.

Of the hundreds of exploration companies listed on the Toronto Ventures Exchange, only a tiny handful will ever discover a mineral deposit that ultimately becomes a mine. Their stock can rise for a while, but it’s bound to eventually fall. These companies raise money to spend on drilling, and when it’s gone, they die. Granted, if they make a major discovery, their stock can multiply many times, but that is so rare it may only happen to one company in a year. Odds strongly favor the value of these stocks falling to a few pennies. In terms of risk, they can’t be compared to owning real gold or silver.

As for producing companies, they also have limitations and drawbacks. Most of them seem to be fully priced and their p.e. ratios are high. Many own prospects in foreign countries that are subject to nationalization or high taxes. Bob Bishop, editor of the Gold Mining Stock Report, recently wrote, “With gold trading at 16-year highs, one would think that the producers would be coining money. One might think that, but one would be wrong. Gold mining is a marginal business for most companies at current prices….. A dearth of new discoveries and higher social and regulatory costs, to say nothing of filling 100-ton trucks with $50 oil-based products and paying high prices for steel, concrete, and everything else that goes into building the rare new mine, and you have what is largely a dollar-trading exercise for many companies today.”

Even the biggest producers can fail and many have in the past. Homestake ran out of gold. Royal Oak never reopened the Giant Yellowknife Mine after a strike and eventually went out of business. Lawsuits abound and mine disasters, environmental problems, anti-mining sentiment and unpredictable governments make mining the chanciest of undertakings. You buy silver or gold to have an asset that won’t lose value when everything else fails. Mining companies don’t come close to offering the same low risk and security as the metal you have in your possession. Yes, there’s room for mining stocks in a portfolio, but never to replace the basic 10% of your net worth in actual physical metal.

In 1987 when the stock market crashed, the gold stocks dropped over 40% in a day. You couldn’t get out of gold mutual funds and liquidity was impaired in the gold stocks. If the day ever comes when we have a financial panic (they were common in the nineteenth century), don’t expect some guy on the fortieth floor in New York to return your call. If everybody heads for the exits at once, they aren’t going to be wide enough. You may not be able to get out.

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