Should You Own Gold or the Gold Producer?
Source: Seeking Alpha, Jim Van Meerten (6/9/10)
Focus is on the relationship between risk and reward.
The main issue is supply and demand. When supplies are low and demand is high, the price goes up. When supply is high and demand is low the price comes down. Sounds simple but it's really not. Other things affect supply and demand: what causes the supply to go up and down and can the supply be controlled by any type of cartel? What causes the demand to go up and down and can another commodity be substituted if demand gets too high?
The Commodity Producer
Now things really get complicated. Producers' profits are not only affected by the price of the commodity—which affects their revenue but all the other factors of an operating entity come into play. What is their cost of extraction? How efficient are they and do they just extract or do they also refine and fabricate? How effective is their management and sales force in marketing the commodity? How effective is their capital management in keeping financing costs down? What are the odds of this producer earning higher profits than the other producers. Are they a big fish in a big pond or are they a small fish in a big pond?
As with all investments, the focus is on the relationship between risk and reward.