The Securities and Exchange Commission is clear in its warnings about the risk involved in investing in microcap or penny stocks. Many financial advisers also warn about the risks of investing in small gold mining companies. Although there is evident risk in buying gold mining penny stock, if you do thorough fundamental and technical research into the companies in that sector, it is possible to find one that might make you money.
Penny Stock Risks
Penny stocks are low-priced stock, generally trading below $5 per share, that are traded on the over-the-counter market. They normally don't report their financials and important company news to the SEC so it is difficult to obtain information on their operations and profitability. Aside from lack of available information, penny stocks often are involved in stock promotions called "pump-and-dump" schemes. In these, a stock promoter attracts buying interest for the stock by sending out stock-tip emails or calling investor lists with predictions that the stock is set to significantly increase in price. Once the stock price rises, the promoter dumps his own shares on the market to collect payment from the sale proceeds,which drives the price down. Penny stocks also can be illiquid -- when the stock is not being actively promoted, there might not be enough normal buy interest in the stock for a stockholder to sell shares easily.
Gold Mining Stocks
Many gold mining penny stocks are very small operations that have unproven reserves of gold. Some find enough gold to be profitable and others don't. Profits in a gold mine depend on the commodity price of gold, which can fluctuate widely. High gold prices attract would-be miners, but by the time the mine is producing, the price of gold can be below what is required to make a good profit. Mining requires heavy equipment and employees, so it is an expensive operation. In addition, finding the gold can be tricky and sometimes a mining claim that looks promising yields little if any gold. Many gold mining stocks are traded on the Toronto Stock Exchange and the domestic penny stock market, so reporting as required by the SEC is often not followed by these companies.
What to Look For
Gold mining stock expert Kenneth J. Gerbino recommends looking for mining companies that have their reserves verified by respected outside authorities. Inferred resources are not enough to justify your investment. He considers 2 to 3 million ounces of reserves as the minimum appropriate for investment. Look for rich ore that produces at least 2 grams of gold per ton of rock with low costs of production, including mine locations that aren't too remote or difficult to mine. Also consider the experience of management. Look for mining engineers with at least a decade of experience mining gold. Before buying, check the stock's price chart to see if there have been spikes in price due to promotional activities. A gradual increase in price over time is preferable to volatility that could indicate pump and dump promotions.
Make an Informed Investment
Uncertain economic times often are accompanied by a surge in goldbugs touting investment in gold as a way to protect your personal wealth from inflation, a drop in the value of the dollar on currency markets or conspiracies to harm the nation. When the commodity price of gold starts to rise, many people are attracted to gold investments, hoping to capitalize on these concerns. And as gold continues to rise in price, old mines re-open and new mines start development. Resist high-pressure sales pitches and take the time to call the company directly to ask about its reserves, how they were validated, whether they report their news and financials and whether the mining company has other mines that are producing. The effort you put into verifying the fundamental value of the mining company helps to reduce the risk of investing.
Victoria Duff specializes in entrepreneurial subjects, drawing on her experience as an acclaimed start-up facilitator, venture catalyst and investor relations manager. Since 1995 she has written many articles for e-zines and was a regular columnist for "Digital Coast Reporter" and "Developments Magazine." She holds a Bachelor of Arts in public administration from the University of California at Berkeley.