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Stocks vs. Bullion
Gold mining stocks or gold bullion? Setting aside the benefits of owning physical gold, if gold stocks are more highly leveraged to the price of gold, wouldn't it always be better to invest in mining stocks rather than bullion (or bullion ETF's)? The short answer is no, it's not always better to invest in mining stocks. The reason is that mining stocks are more volatile and riskier than bullion. As can be expected with all investment vehicles, the possibility of a greater return entails taking on greater risk.
When commodity prices are low, mining stocks will generally outperform bullion. However if commodity prices are high or rising, then the profit margins of the miners will be decreasing and their profits will suffer. Also when the stock market as a whole declines, the price of gold mining stocks tends to fall along with it regardless of the bullion price or the stocks' long-term prospects.
In addition to all of the factors that influence the bullion price, mining stocks are subject to exploration risks, depletion of reserves, environmental risks, worker strikes, and political risks especially in developing countries that may be unfriendly to capitalism. Considering large cap mining stocks, the leverage to the bullion price is relatively low and probably does not outweigh the added risk. But when it comes to junior miners and exploration stage stocks, their potential profits can far outweigh the risks.
In order to see which is currently performing better than the other, stocks or bullion, one can plot the ratio between the two. In the following chart the AMEX Gold Bugs Index (HUI) represents the mining stocks and GOLD the gold price.
You can create a similar chart for yourself by going to StockCharts.com and creating a SharpChart with $HUI:$GOLD as the symbol. This will give you the ratio of the Gold Bugs Index to the bullion price. A rising line indicates that mining stocks have been outperforming gold.
Summing up, mining stocks are more volatile and riskier than bullion shares. Rising commodity prices, especially oil, increase mining costs and lowers profits. Mine specific and geopolitical factors also add to increased risk. However, the returns of mining stocks can be much greater than that of bullion. Charting the ratio of mining stocks to the gold price shows, in general, which one has been outperforming the other.