Investors looking for gold returns can make the right moves—or the wrong moves

The price of gold appears undervalued to many investors in light of the expansion of the money supply by many governments and the risk of inflation. Those investors believe that this is excellent time to stock up on gold and gold stocks. These investors believe that will lead to big gold returns that will provide them with a hedge against stock market volatility. At lower prices, these investors feel they have a chance to receive great gold investing profits in the long term.

For those investors interested in gold investing, we know of two profit-killing strategies that will likely ruin your gold returns. We’ve also included our preferred approach for improving your gold investing profits, which you can read below.

Strategy #1: Gold futures

When gold prices are high, it 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. This is a sure fire way to cut into your long term gold returns.

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. 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.

Strategy #2: Structured investments

Brokers sell various structured products for investing in gold and other commodities, while supposedly limiting risk. These include GICs linked to the performance of gold prices and other commodities. Most participants will ultimately lose money in these investments, as well. Or they will make poor gold returns in relation to their risk. The difference between gold investing in structured products and futures trades is that the losses won’t happen so quickly. In addition, more of the money you lose will flow into brokers’ fees and commissions, while you’ll typically lose less on the commodity investments themselves.

What’s a mining stock?

Mining stocks are investments in companies that produce or explore for minerals, such as uranium, coal, molybdenum (which is used in steelmaking), copper, silver and gold.

Mining stocks can generally be broken up into two categories, majors and juniors. Majors are mining companies that have been in the mining business for many years and more often than not they operate on a global scale. Majors have proven methods for exploration and mining, and have consistent output year over year.

Junior mining stocks are mining companies that are new or have been in business for a decade or less. They are usually smaller companies and take on risky mining projects. If a junior mining stock is successful at finding a mineable deposit, it can mean huge returns for investors.

Here’s a lower-risk way to increase your gold returns

We feel that investing on the basis of price changes for commodity investments, instead of in commodity stocks, 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, negating any potential gold returns you might have realized.

A far better way to profit from rising gold is by investing in gold stocks. That way, your gold investing benefits from increases in production, as well as 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 modest portion of your portfolio’s resources segment.

Buying gold as an investment: seven guidelines we use to pick gold-mining stocks

1. To increase your gold returns, look for well-financed companies with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests.
2. High-quality gold stocks should have strong balance sheets with low debt. Junior mines should have a major partner who can finance a mine to production.
3. Another key ingredient is an experienced management team with a proven ability to develop and finance a mine.
4. We think you should avoid stocks that trade “over the counter,” where such things as regulatory reporting are lax.
5. We also recommend avoiding stocks that are trading at unsustainably high prices as a result of broker hype or investor mania.
6. Compare the market caps of the stocks with the estimated value of their assets or future earnings streams. Some need to quickly find a mineral deposit and begin production to justify the current share price and avoid collapse.
7. Above all, you should automatically rule out investing in companies that promote themselves too aggressively, or do so misleadingly. Success is more likely if the managers focus on finding or developing a mine, rather than touting their stock.

What kinds of gold returns are you expecting in the next couple decades? Share your insight and experience with us in the comments.

This post was originally published on January 30th, 2016 and is updated frequently.