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Stock No Substitute For The Real Thing
In a bull market for real assets, financial assets are no substitute. Mining stock is a financial asset. Bullion is a real asset. Mining company stock is likely to handily outperform other types of stock in a gold bull market, but it is nevertheless still fundamentally stock, a paper asset, not gold.
In the 1970's bull market, gold bullion went up by 2400% and the best of the producing gold mining companies only went up 300%. You would have had to guess the right junior mining company in order to beat the performance of bullion.
Part of the reason for this is that equities are future money discounting mechanisms just like bonds. When P/E ratios are below 10 that means earnings yields are over 10% - analogous to bond yields. Dividend yields are precisely analogous to bond yields. You can think of a stock as a bond in which the future coupon payments are variable, based on the fortunes of the company.
Most of the multiple compression in the 1970s and the multiple expansion of the 1980s and 1990s was part of the same phenomenon as the price to yield compression and expansion of bonds. The rate of discount of future money changed. The only difference with stocks is that the expected future cash stream itself is higher if payouts are expected to grow and vice versa.
That is why mining stocks will face a headwind compared to bullion and futures if bonds sell off and interest rates rise. The expected future cash flows may grow enough to overcome it, but an increasing discount rate is a depressant nevertheless. All else being equal, the same leverage embedded in a stock and a future (or margined bullion) must give you a lower return in the stock than in the future in a rising rate environment.
You also have a variety of confounding factors that may cause your stock investment to go bad even if your thesis about gold is correct; company risk, management risk, political risk, etceteras. Whatever you do, do not buy mining stock merely because you are bullish on the commodity the company mines.
My view is that there is nothing at all wrong with putting some of your portfolio in mining stock. This is especially true if you are selecting companies on the basis of fundamentals and taking care to first estimate an intrinsic value of the shares before buying. But it is not a substitute for hard money in your portfolio.
Originally posted by DemonD
In the 1970's bull market, gold bullion went up by 2400% and the best of the producing gold mining companies only went up 300%. You would have had to guess the right junior mining company in order to beat the performance of bullion.
Part of the reason for this is that equities are future money discounting mechanisms just like bonds. When P/E ratios are below 10 that means earnings yields are over 10% - analogous to bond yields. Dividend yields are precisely analogous to bond yields. You can think of a stock as a bond in which the future coupon payments are variable, based on the fortunes of the company.
Most of the multiple compression in the 1970s and the multiple expansion of the 1980s and 1990s was part of the same phenomenon as the price to yield compression and expansion of bonds. The rate of discount of future money changed. The only difference with stocks is that the expected future cash stream itself is higher if payouts are expected to grow and vice versa.
That is why mining stocks will face a headwind compared to bullion and futures if bonds sell off and interest rates rise. The expected future cash flows may grow enough to overcome it, but an increasing discount rate is a depressant nevertheless. All else being equal, the same leverage embedded in a stock and a future (or margined bullion) must give you a lower return in the stock than in the future in a rising rate environment.
You also have a variety of confounding factors that may cause your stock investment to go bad even if your thesis about gold is correct; company risk, management risk, political risk, etceteras. Whatever you do, do not buy mining stock merely because you are bullish on the commodity the company mines.
My view is that there is nothing at all wrong with putting some of your portfolio in mining stock. This is especially true if you are selecting companies on the basis of fundamentals and taking care to first estimate an intrinsic value of the shares before buying. But it is not a substitute for hard money in your portfolio.
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