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Mark's Market Blog

Part III: Gold and Natural Resources

By Mark Lawrence

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There are a lot of ways to invest in natural resources or commodities. You can buy the commodity directly - you can go buy a couple pounds of gold or platinum or palladium and take it home. Historically this has been a very safe investment, but not a very rewarding investment. You can buy stocks in companies that own gold, or companies that mine gold, or companies that prospect for gold. There are similar opportunities for other commodities. You can also buy futures. A future is a contract that says on some particular day in the future, you have the right to buy a certain amount of some commodity at some particular price. If you have a 6 month gold future at $350 / ounce, and six months from now gold is $400 / ounce, then in six months you can buy the gold for $350 / ounce and sell it immediately for $400 / ounce, realizing a $50 / ounce profit. If in six months the price of gold is $349 / ounce or less, your contract is effectively worthless, and you're out the money you paid for the contract. Large mining and farming corporations use future contracts to sell risk and guarantee their income. If a mining operation sells a lot of gold futures, then they are guaranteed at least the future price specified in the contract. This is a way of separating the management of the farm or the gold mine from the risk of the price changes in the commodity. The farmer must decide in the spring how many acres of land he will devote to each crop, based on what he thinks the crop will sell for at harvest time. Wheat futures are a way for him to lock in his selling price at the time of planting, so that he can concentrate on growing the wheat. The buyer of the future contract assumes the risk and potential rewards from the price changes in the wheat while it's growing.

Gold has a couple of unique properties as an investment. It's small and reasonably portable, and you can buy and sell gold fairly easily. If you're afraid of banks or governments or whatever, owning a bit of gold might be a good choice for you. However, the gold market is heavily monitored and manipulated by governments and central banks, and heavily hedged by the gold mining industry. Historically, gold has not been a good growth investment for small investors. I think as an investment gold is only useful as a hedge against major societal breakdown.

Some metals are used heavily in manufacturing, for example Platinum, Palladium, and Titanium. These metals can be a good investment if you understand the manufacturing needs, the mining production, and the market. They are not for casual investors.

This is an investment area where one must be especially careful. There are a lot of people selling shares in "gold mines" and "oil wells" where neither the mine nor the well have ever existed. When a legitimate exploration company sells you shares, you must keep in mind that they are selling risk and you are buying risk. They keep your money whether or not they are successful, you only get paid if it all works out. The reward in this field can be quite high, but the risks are also quite high. Most professional geologists in Nevada never find a gold mine in their entire career. In fact, it's common practice in Nevada to drill a few sample shafts where you will put the dirt from a working mine: it would be a huge mistake to put thousands of tons of dirt on top of what is later found to be another good gold mine. This is called condemnation drilling. The mining companies all have large teams of geologists who tell them where gold will most likely be, and where it will almost certainly not be. Dirt is to be piled up on top of the places where the geologists think gold cannot be. Condemnation drilling is the #1 source of new gold strikes in Nevada. Each time this happens, there is a geologist somewhere who was as wrong as you can possibly be.

You can invest in these areas in a relatively safe fashion, however. There are index funds and mutual funds and ETFs that specialize in natural resources and energy. At the time of this writing (7/05) oil prices are increasing very quickly, and energy funds are doing especially well. I'm also getting a lot of phone calls from people asking me if I would like to invest in their oil wells and maybe get fabulously rich. I have some money in energy funds, which is doing quite well. I am not buying shares in any oil wells.

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