What is the best way to invest in gold? Are gold mining stocks a good investment? Discover for yourself in this quiz on gold investing

Are gold mining stocks a good investment? The best gold stocks will generate positive cash flow even with low gold prices—and also offer rising production outlooks. However, due to their volatile nature, we continue to recommend that gold investments be made accordingly, and only make up a limited portion of your portfolio’s Resources segment.

Test your knowledge on gold investing below.

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A. Which of the following makes gold of interest to investors?

1. Gold is a highly specialized commodity
2. Gold mining production is somewhat predictable
3. Gold bullion rarely ever gets permanently lost or consumed
4. All of the above
5. None of the above

You are correct if you answered 4.

Unlike stocks which represent a share in a profit-seeking enterprise, gold is a commodity, and a highly specialized one at that.

Gold is the only commodity that rarely if ever gets permanently lost or consumed. This means that virtually every ounce of the metal that has ever been produced may one day come back on the market. That’s why it’s a mistake to try to predict gold prices as you would wheat prices, for example, by comparing estimates of supply and demand for the coming year.

Gold mining production is somewhat predictable, like the production of any commodity: It varies with how miners react to operating costs and market prices. Still, gold demand also depends in large part on investor psychology. Investors may choose to buy or sell gold, depending on how they feel about the outlook for the economy or inflation.

B. True or False: The best way to invest in gold is through bullion.

You are correct if you answered “False.”

Under the Successful Investor approach, the best way to invest in gold is through gold stocks. We recommend staying away from buying gold bullion, coins (unless you collect them as a hobby), or certificates representing an interest in bullion.

C. The biggest reasons to stay away from gold bullion investing include:

1. Bullion comes with a cash drain from management and processing fees
2. Bullion requires insurance fees
3. Bullion needs to be stored, which costs money
4. All of the above
5. None of the above

You are correct if you answered 4.

Gold investing through bullion does not generate income. Instead, bullion and coins come with a continuing cash drain for management, insurance, storage and so on. We think you should limit your gold investments to gold mining stocks. Unlike bullion, gold-mining stocks at least have the potential to generate dividend income.

D. In 2011, the peak of gold hit:

1. $850
2. $775
3. $1,000
4. $1,900
5. None of the above

You are correct if you answered 4.

Gold hit a low at around $250 in April 2001. At that level, it was down more than 70% from its 1980 peak of $850. The real loss was much greater for those holding gold bullion, considering the added insurance and storage costs.

After hitting its 2001 low, gold set off on a 10-year rising trend that carried it up to $1,900. From its 1980 peak of $850 to its 2011 peak of $1,900, gold rose at an average annual compound rate of 2.4%. Gold is now at $1,483.

E. All of the following are smart ways to invest in gold mining companies, except:

1. Look for gold stocks that trade over the counter
2. Avoid companies that promote themselves too heavily, or misleadingly
3. Invest in gold mining companies with an experienced management team with a proven ability to develop and finance a mine
4. Find gold stocks with strong balance sheets and reasonable debt
5. Look for well-financed companies with no need to sell shares at low prices

You are correct if you answered 1.

When it comes to investing in gold mining stocks, we think you should avoid stocks that trade “over the counter,” where such things as regulatory reporting are lax.

Some of the most highly promoted gold mining stocks are penny stocks which have yet to produce an ounce of gold. Many must still add to their reserves, if they have any yet, 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.

However, the best gold stocks have strong reserves, low production costs and are already producing gold. They may also have a range of development projects, but their strong base of production cuts the risk of relying on new developments alone. Furthermore, we look for well-financed gold stocks with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests.

Remember, the very best gold stocks all have strong balance sheets and reasonable debt.

Bonus tip: Use our Successful Investor approach to invest in the best stocks—including gold mining stocks

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

Even with the volatility, are gold mining stocks a good investment in your eyes?

What would you suggest to an investor interested in gold mining stocks?