Here are two gold investing mistakes that will virtually guarantee you will lose money

We feel these two gold investing mistakes can hurt your overall profits—so we’re going to tell you about them right away. (As an alternative, we’ve also included our preferred approach and a top buy in gold stocks, which you can read about below.)

The first of the gold investing mistakes you should avoid is gold futures: Rising gold prices can make trading gold futures look more attractive. However, you can only profit in future-linked deals by out-guessing other futures traders by a wide enough margin to cover commissions and other trading costs. When you dabble in commodity futures, you are betting against professionals who make a full-time occupation of studying these markets, who have better access to information than you do, and pay much lower commissions.

Most futures traders start out with a planned limit on how much they are willing to lose before they quit. In six months or so, most lose that amount, and quit trading. What’s more, because futures traders tend to trade often, a surprisingly large number find that the total brokerage commissions they pay during their trading career is close to the total losses on their commodity investments.

The second gold investing mistake is structured investments: Brokers sell various structured products for investing in gold and other commodities, while supposedly limiting risk. Most participants will ultimately lose money in these investments, as well. Or they will make a poor return in relation to their risk.

An example is 5-year Gold Linked Deposit Notes, issued recently by HSBC Canada. These are tied to movements in the spot price of gold (but after fees!).

The difference between structured products and gold futures trades is that the losses won’t happen so quickly. However, more of the money you lose will flow into brokers’ fees and commissions, while you’ll typically lose less on the commodity investments themselves.

Stick with shares of gold-mining firms when investing in gold

We feel that investing on the basis of price changes for gold in the form of bullion, instead of in shares of gold companies, is more of a gamble than an investment. These activities don’t earn income, but instead consume funds for storage fees, insurance and so on.

A far better way to profit from rising gold is by investing in the stocks of gold-mining companies. That way, you benefit from increases in the price of gold, and you give yourself the potential for capital gains and income. You also save on the higher brokerage fees and commissions associated with other types of commodity investments.

Even so, because of their volatile nature, we continue to recommend that gold stocks only make up a limited portion of your portfolio’s resources segment.

Here are 8 of our best tips to avoid gold investing mistakes

1. When you invest in gold, look at how long the company’s reserves are likely to last. Those with low reserves need to have consistent success in their exploration programs to maximize the production of the mine and the surrounding area. That success is far from guaranteed.

   Even if the company has strong reserves, the best gold stocks with the least risk also have a diversified reserve base. That way they are not dependent on a single mine’s production or political stability in any one country. Gold companies can also increase their reserves by making acquisitions—with gold prices down from their record high you may see an increase in gold mining company acquisitions at distressed prices.

2. Some of the most highly promoted gold stocks are penny stocks which have yet to produce an ounce of gold. Many must still add to their reserves, invest in mine-feasibility studies, and raise a lot of money before they go into production. The prospects for most of these penny-mine properties, even though they may be in areas with production from existing mines nearby, are far from certain.

   In contrast, the best gold stocks have strong reserves, low production costs and are already producing gold. They also have a range of development projects, but their strong base of production cuts the risk of relying on new developments alone.

3. When we recommend gold stocks, we prefer those that operate in an area with geology that is similar to that of nearby producing mines.

4. We look for well-financed gold stocks with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests. The best golds have a major partner who has agreed to pay for the drilling or other exploration or development, in exchange for an interest in the property.

5. The best gold stocks all have strong balance sheets and low debt. If you do your due diligence and research, you avoid most of the gold investing mistakes that investors fall victim to.

6. We want to see favourable factors, like exceptionally strong gold showings from extensive drill programs, before we recommend any gold stocks that operate in hostile environments, like the high Arctic.

7. We avoid mining stocks that trade at unsustainably high prices due to broker hype or investor mania about the underlying commodity (such as gold). Instead, we focus on reasonably priced mining stocks with favourable geology.

8. We always look at the market cap of gold mining stocks versus the estimated value of the mineral resource they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of its ore body. We like a gold mining stock’s market cap to be no more than half the value of the gold in the ground. We assume that the company will be able to expand its ore reserves after the mine opens, but if the mineral reserves are double the gold mining stock’s market cap, it provides a margin of safety.

Have you made any gold investing mistakes that we’ve missed? Share your thoughts and experience with us in the comments.