Why Gold Bullion Beats Gold Mining Stocks And Gold Shares - Seeking Alpha

In a comment on Monday's article, a reader stated that "I think gold miners look more bullish than gold bullion." As a former Futures and Options trader and current owner and trader of physical metals, I have never much cared for gold shares and mining stock. In my opinion, owning mining stock or shares is like making a three-way phone call when you can dial direct. The value of a mining stock or of gold shares is not in the company that mines the gold, nor is it in the paper that represents gold, the value is in the gold itself.

In this piece, I will explain the pros and cons of owning shares and mining stock as I see them, and why it's not all that it's cracked up to be. In the name of disclosure, Empower Investments does buy, sell, and trade physical gold, silver, platinum, and palladium, but I ask you to read on with an open mind. While many will say that people who own gold bullion are fearful or conspiracy theorists, I say that those who own shares or mining stock are the fearful ones.

Gold Shares

When you buy gold shares you are buying a piece of paper that "represents" gold when you could just as easily buy the gold itself. The appeal of owning shares is that you can trade it like you would a stock so you don't have to face your fear of doing something new or educating yourself on a different asset class. Likewise, when buying shares, there is no need for storage so investors needn't be afraid of getting robbed or finding/creating a safe place to store their metals. Once they have a piece of paper that represents gold, a lot of investors feel safe, they feel diversified, and they are pleased thinking that they did a good thing. But have you ever seen the gold? Can you trade in your piece of paper for a bar or coin?

SPDR Gold Shares (GLD) is based on the price of 1/10th of an ounce of gold. While SPDR claims to have gold backing its shares in a mystery vault somewhere in London, you cannot take delivery of it. Instead, SPDR Gold Shares gives its investors a simple piece of paper that "represents" physical gold held in another country. Contrarily, I can buy a 1/10-ounce gold coin at any local coin shop in the country and hold it locally in a home safe, or a safe deposit box. A 1/10-ounce coin is about the size of a dime so it is easily stored and companies like mine are happy to educate you and walk you through the process so there's nothing to be afraid of. On the other hand, shares like GLD give me plenty to fear.

In a popular Forbes article, contributor Agustino Fontevecchia puts it this way, "Even though GLD is 'physically backed,' ordinary investors can't just go to London and redeem their bullion. Only 'authorized participants' are allowed to create or redeem shares… Regular shareholders have no rights of redemption and the gold is not required to be insured by the Trust, which is not liable for loss, damage, theft, nor fraud." That's pretty scary indeed.

Fontevecchia continued, "Skeptics have raised doubts over the trust's management of its physical gold, with questions over how much is actually held. HSBC, the custodian, is very secretive regarding its vault. Earlier this year, CNBC's Bob Pisani was allowed to see the vault only after surrendering his cell phone and taken in a van with blacked-out windows to an undisclosed location. Once in the vault, Pisani held up a gold bar and explained they were all numbered and registered. Astutely, ZeroHedge noted the bar Pisani held up was missing from the current bar list, fueling further speculation and skepticism."

To be fair, other trusts like Sprott Physical Bullion Trusts do allow you to take delivery of your gold (PHYS), silver (PSLV), platinum and palladium (SPPP), but like GLD, Sprott's metals are also held outside of the US at the Royal Canadian Mint. Also like GLD, concerns about whether Sprott Trusts actually have the gold or silver your paper represents still exist.

On November 10, 2010, Sprott Physical Silver Trust had contracted to purchase a total of 22,298,525 ounces of silver bullion. As of December 31, 2010, only 20,919,022 ounces of silver bullion had been delivered to the Trust. Sprott stated that the final 1,379,503 ounces would be delivered in mid-January and I believe that it was, but the truth remains that investors bought (paper representing) silver that Sprott didn't have on hand.

In his own words, Eric Sprott, Chief Investment Officer of Sprott Asset Management said that he was "concerned about the illiquidity in the physical silver market," and that "the delays involved in the delivery of physical silver to the Trust highlight the disconnect that exists between the paper and physical markets for silver."

When the boss himself states clearly that there is a disconnect between paper and the actual, physical metal, what further proof do you need? Again, I can go to any local coin shop and buy silver dollars in minutes. In fact, you probably collected them as a kid. And yet, millions of investors put their faith in these paper assets when they can easily own the real thing.

Mining Stock

When it comes to mining stock, you're not buying gold, you're buying a company that mines gold. Whenever I think of mining stock, I think of Kevin O'Leary who most people know from the TV show Shark Tank. However, O'Leary is much more than a TV personality. He is a venture capitalist, but he is also one of Canada's wealthiest individuals, and he is the chairman of O'Leary Funds, a $1.5 billion mutual fund company.

In a recent interview, O'Leary stated that "The reason gold stocks are not performing in tandem with the price of gold comes down to 'idiot management,'" and that "there is no reason to own the miners. If your cost to actually mine an actual ounce keeps going up, why would I ever buy the stock?" He finished by saying "they are mismanaged."

O'Leary isn't alone. In a November Bloomberg Article, Randgold Resources Limited (GOLD) Chief Executive Officer Mark Bristow said, "The one thing this industry does very well is mine gold at a loss." Citing operating costs, Bristow told analysts, "Half of the gold coming out of the ground isn't profitable to mine based on the true extraction costs."

Furthermore, the salary and bonuses these mining stock companies pay their executives are one of the reasons that Gold stocks have underperformed spot price of metal since 2010. In a September Bloomberg article, billionaire John Paulson's firm called for the creation of a coalition of gold mining stock investors to curb years of value destruction stating that, "The days of CEOs getting rich while shareholders lose has got to end," adding that "Management must be held accountable."

In that same Bloomberg piece, the authors point out that "Shares of 15 gold miners tracked by Bloomberg Intelligence... have slumped 59 percent since the end of 2010, compared with a slide of 8.5 percent for the precious metal." Moreover, mining companies have incurred $85 billion of write-offs since 2010 as a result of ill-advised mergers and mine purchases, while still richly rewarding their executive officers according to Mr. Paulson's presentation. Plus, "the net debt of big mining companies tracked by Bloomberg Intelligence surged almost sevenfold over four years to a record $33.2 billion in 2014, fueled by capital spending." Are you scared yet?

Coeur Mining (CDE) is a recent and painful example of mining stock underperforming and failing to meet expectations. A Madison.com article pointed out that "after rocketing 266.5% in 2016, the silver and gold mining stock shed 21% of its value through mid-December. Making that loss even more disappointing is the fact that the prices of silver and gold have risen 3% and 9%, respectively, this year while the broader stock market has been scorching hot, with the S&P 500 rising more than 19%."

The Physical Advantage

Gold mining stocks, funds, and ETFs are a popular investment; however, they are not gold. Tangible gold and silver are not typically used in trading, or for quick turn-around profits. In many regards, owning physical metal is more of an investment while owning representative shares or trading futures are considered more speculative. Having and owning physical gold and silver gives a sense of security that pieces of paper do not.

Plus, physical gold is liquid. Owning tangible metals has protected investors during periods of economic depression, wars, and political unrest. By taking delivery and having bullion in your possession, your investment can be sold for cash at most coin and precious metals dealers worldwide. Whether in London, Beijing, or Russia, an ounce of gold has the same purchasing power regardless of the currency exchange. Passing physical metal to your children and grandchildren is an easy and private transaction. You can own gold and silver bullion as part of your IRA or 401-k so you would reap the same tax benefits that you would when buying a fund or a stock, and the profit potential is huge if you know what you're doing.

Similarly, rare coins or coins with a collectible value have shown themselves to be very profitable in recent years. In a CNBC article written earlier this year, the author, Ryan Vlastelica stated that investment-grade or investable coins "are defined as ones minted between the late 1700s and 1933 when gold ceased to be an ingredient in their construction. Prices are determined both by their scarcity and their condition, and they're scored on a scale of zero to 70." Vlastelica further observed that "between 1979 and 2014, the most recent year for which data is available, coins with a minimum score of 65 posted an average annual return of 11.9%, according to a study by Penn State University. That's near the average annual return of 13% posted by equities and more than twice the 5.5% average annual gain of gold bullion. Coins with a lower score, between 63 and 65, had an average annual return of 10.1%."

With the popularity of Bitcoin and cryptocurrencies as an alternative to our current monetary and banking system, it is worth mentioning that gold has the same appeal, a longer track record, and a higher market cap than Bitcoin. As I stated in a recent blog post, "both Bitcoin and Gold coins are attractive to those who are concerned with inflation, corrupt banks, the stock market bubble, interest rates, national debt, geopolitical concerns, and more." In other words, if you are at all concerned about the banking system, the stock market, or the economy, precious metals provide protection in a tangible form that is recognized around the world.

Real assets provide real diversification, but chances are all of these examples and my reasoning will fall on deaf ears. I was surprised to read that anyone was bullish on mining stocks with what has been happening these past few years, and now you know why. In my opinion, gold stocks and shares aren't worth the paper they are printed on when you can have the real thing. That would be like Facebook (NASDAQ:FB) buying shares of Instagram rather than buying the company outright.

On Monday, another commenter took issue with my use of a Warren Buffett quote because Buffett is not a fan of owning gold. However, I think that there is wisdom in some of the things Buffett has said about the metal. I like this quote in particular:

"The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end." - Warren Buffett

As a hedge, as protection against instability, while CEOs bonus their companies into the red and trusts sell gold and silver they may or may not have… that you may or may not be able to take delivery of, at the end of the day those who own physical metals will know where they stand. As Buffett says, we will still own gold.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.