Warren Buffett has publicly (and frequently) written about what he considers the folly of investing in gold: Gold doesn’t produce any tangible values – neither products nor services. This article argues why Buffet is right about gold. However, are gold mining stocks a better investment than gold bullion?
This article looks at the performance of gold bullion versus gold mining stocks. Which one is better to own? Which one is riskier? Gold or gold mining stocks? Should you buy the metal or the companies/stocks? The gold price has outperformed the gold mining stocks by a wide margin.
At the end of the article, we explain why we believe gold bullion and miners are poor investments in the long run.
Is it better to buy gold or gold miners (gold mining stocks)?
Which way is best to get exposure to gold? Should you buy the metal or get exposure via mining companies?
Let’s jump right into it. We calculated how an investment in gold and gold mining stocks performed from 1985 until the summer of 2020:
We used the XAU index as a proxy for the gold miners (blue line), and it’s pretty clear that gold mining stocks underperformed the gold price by a wide margin from 1985 until the summer of 2020 (gold is the red line).
We believe it makes sense. There are plenty of arguments why mining stocks over time is a poor investment:
Gold mining risk:
Let’s look at some of the risks of owning gold mining companies. We have never owned mining stocks, and we most likely never will for these reasons:
Miners face exploration risk (gold bullion doesn’t):
Drilling might come up blank. It costs a lot of money to research, drill, and explore. Most of the time to no avail. CAPEX is huge.
Miners have management risk (gold bullion doesn’t):
As with any company, you face risk from poor management decisions.
Miners have huge environmental risk:
Regulation might change at a dime. The red tape for exploring gold is enormous and most likely continues to increase. Add to this litigation costs. A tail event can create substantial financial damage.
Miners are at the mercy of the bullion price (pricing risk):
The gold producers are at the mercy of the gold price, which they have no influence on. If prices fall, a gold miner can be put out of business.
Miners can face financial risk (gold bullion doesn’t):
Mining and exploration are naturally very capital-intensive and cyclical – a nasty combination. It’s a very fragile business:
Add financial leverage into the mix, and you face a high risk of financial ruin or potential dilution risk.
Many speculators buy miners when they believe the gold price will go up because of the financial leverage in the mining companies. This might work in the short run but not in the long run.
Miners are prone to geopolitical risk:
Gold miners are exposed to risk from bad political decisions. Many miners operate in regions where the rule of law is weak. Add to this increased risk of heavy taxation after years of government overspending in many parts of the world. Mining rights are easy prey for cash-strapped governments.
Miners have productivity risk:
Fuel is one of the biggest expenditures of gold mining. 2020 offered high gold prices and low fuel costs, but it is just as likely to go the other way. Add to this labor issues and strikes. Gold mining is one of the most dangerous occupations there is.
Even if a gold miner finds a new deposit, it might not be feasible to mine due to costs, and not to mention the gold price.
Miners can’t get a moat around their business:
Warren Buffett wants to invest in companies that have a “moat”. Unfortunately, mining stocks have no pricing power. They are entirely at the mercy of forces they can’t control, and thus they can never get any moat.
Miners have low returns on capital:
The mining industry has, in general, low returns on invested capital. Why would you invest in such a business?
Miners face many risks:
Mining stocks are one of the most volatile on the stock exchange. According to financial theory, you should get rewarded for taking this risk, but that is not the case.
Another risk is hedging. Most miners hedge all or parts of their production and might not take benefit of any rise in their metals.
Gold bullion risks
What are the risks of owning gold bullion?
You can lose ownership of your gold bullion:
The greatest risk is losing it. This can happen by robbery, or government can simply outlaw owning gold. It’s not as far-fetched as it sounds. The US outlawed gold for about 40 years until 1971, and countless vaults were robbed.
Gold requires costs related to insurance and storage:
You can bury your gold in your garden, but we recommend using a storage facility. However, that costs money both for storage and insurance.
How much does this cost? For example, the British company Bullionvault charges 0.4% annually for taking care of your gold (disclosure: we use this service).
Gold has no productive benefits:
Gold doesn’t produce any products or services. It serves only as a store of value, which it has done reasonably successfully for thousands of years compared to many assets.
There is more paper gold than actual gold:
Many are surprised to hear that there is more paper gold than physical gold. Why? Because gold can be traded via derivatives on exchanges. Gold is prone to speculation.
Gold is a poor way to invest over time (gold is not a good investment over time):
Because gold doesn’t produce anything, you are better off investing in productive assets over time, like stocks or real estate.
Gold fluctuates based on monetary policies
Gold is used as a hedge to protect assets from inflation. Thus, the gold price is mostly determined by central bankers.
Why gold is a bad investment -you shouldn’t own gold (for the long-term)
We have a tiny part of our portfolio invested in gold bullion, but over time gold is a poor investment:
Why is gold a poor investment over time?
Because gold doesn’t produce anything. When something doesn’t produce any tangible values, you have no retained earnings you can reinvest to get exponential/compounding growth:
Gold has been used for thousands of years as money and a store of wealth. Gold bugs love this argument, but they compare it against fiat.
We believe it’s a faulty comparison. Why would you compare the opportunity cost to fiat if the opportunity cost is the return from stocks? Gold is not used to exchange goods and services for which fiat is used. It’s like comparing oranges and apples.
The only comfort is that gold mining stocks are an even worse investment than gold bullion. If you want a store of wealth, we believe the stock market offers better opportunities.
However, because of the low correlation to stocks, a part of your portfolio might benefit from owning gold. We have covered this in a separate article:
This article has looked at gold vs. gold miners. Physical gold bullion is far superior to mining stocks in the long run. You don’t get rewarded by undertaking all the risks involved in mining stocks.
Moreover, gold, in general, is a poor investment compared to the opportunity costs missed by not investing in the stock market. Gold might be shiny and attractive, but don’t let emotions interfere with your investment decisions. Over the long-term, productive assets that can compound are the better investment. Nonetheless, a portfolio might benefit if you add a small portion to gold because of the low correlation to stocks.
We believe you should only buy gold if you are a market timer, short-term trader, speculator, or use it to balance your overall portfolio.
Disclosure: We are not financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinion – they are not suggestions to buy or sell any securities.
How does the performance of gold bullion compare to gold mining stocks?
Warren Buffett argues that gold doesn’t produce tangible values like products or services, making it a less favorable investment compared to productive assets, historically, the gold price has outperformed gold mining stocks, as indicated by the XAU index.
Is it better to invest in gold or gold mining stocks?
Risks associated with gold mining stocks include exploration risk, management risk, environmental risk, pricing risk, financial risk, geopolitical risk, productivity risk, lack of pricing power, and low returns on capital. The analysis suggests that gold may be a more favorable investment than gold mining stocks due to the various risks associated with mining companies.
Why is gold considered a poor long-term investment?
Gold is deemed a poor long-term investment because it doesn’t produce anything tangible, lacks retained earnings for compounding growth, and is compared unfavorably to productive assets like stocks or real estate. Despite these gold is used as a hedge against inflation, and its price is influenced by monetary policies set by central bankers.