Why Include Gold Mining Stocks in Your Portfolio?

If you are interested in diversifying your investment portfolio, you've probably thought about precious metals. After all, precious metals like silver, gold, and platinum often beat the market when it comes to stock market crash.

Stock market crashes are cyclical; they happen at least once a decade if not, twice a decade. Crashes happen when market valuation outpace underlying financial fundamentals that a market goes into a long period of correction.

It's always a good idea to diversify in either real estate or precious metal to handle periods of economic uncertainty, economic downturns and financial crashes. The problem with diversification is that you are faced with a lot of choices, it's not like you only have one specific choice when it comes to precious metals in your portfolio. One of the best places to diversify into, are gold mining stocks – this is not as clear cut as you may think. Keep the following factors in mind if you are thinking of including gold mining stocks in your portfolio.

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The fundamentals of gold miner stocks

Gold miner stocks are companies that mine for gold – that much is obvious. However, you should look at these companies, not as pure gold plays. This is one of the most common mistakes that rookie investors make.

When they look to gold mining stocks, they think that this is a good stand-in for gold ETFs or other gold investing methods. This would seriously be a bad mistake. Keep in mind that if you are investing in gold mining and gold miner stocks, you are essentially investing in stocks. Therefore, you have to apply the same analysis and investment strategy that you adopt when investing in stocks.

The main value that these gold miner stocks bring to your portfolio is primarily due to the market's valuation of the companies behind these stocks, it's not so much the gold. Although gold and other precious metals play a factor, this is a stock play at the end of the day. If this is a pure precious metal's play, then all gold miner stocks would have the same impact on your diversification strategy as any other gold miner stocks, but this is obviously not true.

The market has a very interesting and often irrational way of valuing companies. In many cases, they would value the company based on hype and buzz. There's really no other way to describe why the stock rise on Twitter is so high, except for hype and buzz. The same could be said on a purely price per earnings ratio analysis of Facebook and other high-flying social media stocks. With that said, you really have to zero in on the factor that gold miner stocks are still stock plays, they're not pure diversification plays. Once you have that cleared up, then you can proceed to the analysis below.

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Somewhat predictable market insurance movements

One of the great things in going for gold mining stocks and gold miner stocks is that when the market crashes, it's a question of when, not if, you can expect these stocks to increase in value.

If you play your cards right, you can put yourself in a position where you increase your chances of not just breaking even, but taking advantage of a depressed stock market. This has happened in 2008 and 2001. In fact, this is not a typical bare market play. The investors who think that the market is going to crash would often park the bulk of their investment portfolio in precious metals and other commodities that often spike up when the rest of the market crashes. When they do this, the resulting increase in the commodity prices offsets the greatly discounted prices of their equity holdings.

They come out ahead when the disparity is so high that they can afford to unload some of their precious metal holdings so they can scoop up very depressed stocks. Using the dollar share, averaging lock in has a very low price for their stock holdings. It only takes a modest or even anemic recovery of the market for these speculators to come out ahead using this strategy. This may seem fanciful to you considering the fact that the Dow Jones is flirting with 17,000 and the NASDAQ is setting all sorts of records.

Keep in mind that you have to draw your timeline across a time frame of maybe 40 years. If you see that pattern, then you would see that the correction is coming soon.

Usually, people who predict stock market prices are often dismissed as alarmists or overly pessimistic up until the crash happens. Keep in mind that the most recent crash that the global endured, the 2008 crash precipitated by the Lehman brothers, was predicted 4 years ahead of time.

You can look through YouTube and see many financial commentators laughing at people like Schiff and others who predicted the crash correctly. It's coming – it's just a question of how you will position your investment portfolio so that you will not only survive the financial slaughter but actually make money off the upcoming financial catastrophe.

Gold mining stocks can help you invest in industry winners well-positioned to shore once there is a correction.

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Selection pressures

There are going to be a lot of selection pressure in the short term when it comes to gold mining stocks because of the fact that they are primarily stock plays, you have to keep this in mind.

Whatever gains you may have when the market crashes, and there is a flight to quality because people are heading for the exits and buying gold and precious metals, might be offset by the fact that you are still betting on stock plays.

One way to get out of this dilemma is to take a look at Australian gold mining plays and maybe even Americans in Anglo-American gold mining plays that have historically had a very decent rise to earnings ratio, have a very solid book value, and very low debt. This is crucial.

Company debt levels can impact its ability to take advantage of increased market demand for precious metals. Gold miner stocks are not created equal, some are better positioned than others.

Analyze their books the same way you would when you look at a book to price value, or look for a book to price ratio. This is not a slam dunk, but it definitely gives you a defensive play since you're making your selection very conservatively.

Expect to pay a premium since you probably entered this position near the top of the market. However, if you pick the right companies, whatever erosion you would experience due to the stock end of this play would be more than offset by the fact that you are picking a well-positioned precious metal global industry player.

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