Gold Miners vs. Gold ETFs

LONDON -- The price of gold has risen by 455% in the last 10 years, sparking a massive boom in gold investment.

Many investors have chosen to invest in gold directly, usually via an exchange-traded fund, or ETF, but the strong and sustained rise in gold prices has also driven a boom in gold mining as companies exploit reserves that would not have been cost-effective 10 years ago.

So where should you put your money?

The case for gold ETFs
It's worth noting that many people invest directly in gold as a hedge against serious inflation, financial crashes, and other such calamities. They consider it an alternative to cash, not an alternative to shares.

Although the price of gold is more closely correlated to stock market performance than it used to be, the yellow metal does still provide protection against inflation and the other side effects of printing money, something Western governments seem pretty keen on doing at the moment.

Gold ETFs, such as the SPDR Gold Trust (NYS: GLD) , Gold Bullion Securities (ISE: GBS.L) and ETFS Physical Gold (ISE: PHAU.L) , provide investors with the ability to directly track the price of gold through a fund, making owning gold as simple as owning shares, and meaning that you can easily put gold in your ISA or SIPP.

Anyone who bought shares in one of the gold ETFs five years ago will now be sitting on a 129% profit -- not bad, considering that the FTSE 100 (UKX) has dropped 12% during the same time.

Mining for gold
There are two problems with investing directly in gold. The first is that gold doesn't pay dividends, and the second is that gold doesn't produce anything. You can't increase the productivity of a lump of gold, nor can you expand or improve it.

That's why investing in gold miners can be more profitable than investing in the yellow metal itself -- successful miners can expand their gold production continuously for years or even decades, generating impressive growth.

An African success story
Shareholders in Randgold Resources (ISE: RRS.L) (NAS: GOLD) should understand this all too well. Shares in this Africa-focused gold miner have risen by 347% over the last five years, propelling it into the FTSE 100 just 17 years after the firm was founded in 1995.

Randgold reported a 41% increase in profits in the first half of this year and a 16% increase in gold production. Cash costs per ounce for the six months were $723 -- roughly half the spot price of gold, highlighting the massive profits gold miners can make when they get it right.

Yet this isn't the easy money it may appear to be. Randgold has proven itself skilled at building relationships and developing big projects in difficult geopolitical environments, where other companies have often failed.

Its main projects are in Mali, Cote d'Ivoire, and the Democratic Republic of Congo, or DRC, and civil unrest and volatile tax and political regimes are a constant threat to its business, in addition to the possibility that gold prices will fall.

Earlier this year, Randgold's share price fell by 20% in a week when civil war broke out in Mali, and only yesterday the company's chief executive, Mark Bristow, gave a speech in the DRC urging policy makers to resist the temptation to hike mining taxes to take advantage of current high gold prices.

Not so impressive
Randgold's achievement is more obvious when you compare its performance to that of two other large London-listed gold miners.

Shares in Russian gold miner Petropavlovsk (ISE: POG.L) have fallen by a whopping 67% over the last five years, despite the price of gold rising by 129%! Centamin (ISE: CEY.L) , which mines gold in Egypt, has also underperformed its core commodity, delivering a gain of just 57% over the same period.

Identifying successful miners
If you want to make money from gold, then the biggest gains can come from investing in early stage gold miners that make it big -- such as Randgold Resources, whose share price has risen by 1,888% over the last 10 years. However, for every big success there are several failures that will cost you money, even as you watch the price of gold rise.

Learning how to identify the best mining shares is the key to success in this sector, and if you are interested in investing in miners then I would strongly recommend the free Motley Fool report, "The Market's Top Sectors." This report identifies three key sectors for private investors to consider, including mining.

Two excellent mining shares are recommended by Fool analyst Charly Travers, including one exciting smaller miner that mines gold and silver but operates in South American countries where the geopolitical environment is much more stable than in Africa.

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Roland Head does not own shares in any of the companies mentioned in this article.The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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