Want to invest in gold? Here are some options

It’s worth considering more than just the physical commodity or mining stocks.

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Until recently, the selling of gold has been relentless and the selling of gold miners has been catastrophic.  If you were not invested in gold related stocks when they crashed and burned than congratulations.  However, given the carnage in the sector, is it time to start looking at some of the battered stocks?  If so, how do you play it?

Individual miners

One option is to invest directly in those companies that explore and develop the mines.  However, individual gold miners generally carry a significant amount of risk unless they are well financed, geographically diversified and profitable in lower pricing environments.

When gold prices drop, financing for projects dries up and the junior miners get hit particularly hard.  Buying the senior miners can alleviate some of this risk, but they still bear the risks associated with specific mines and geopolitical events.

Look no further than what has happened to the largest and most diversified of gold miners.  Shares of the once mighty Barrick Gold Corporation (TSX: ABX) have been crushed and at one point were down as much as 66% from their 52-week high.

Barrick is also a good representation of the risks associated with individual mines.  Environmental and regulatory concerns on behalf of Chilean authorities caused the company to suspend construction on the Chilean side of its Pascua-Lama mine until a more environmentally friendly water management system is complete.  Shares slid 33% within a week after the initial announcement and remained in a downward trend falling another 21.7% to reach a 52-week low of $14.22.

There is little doubt shares of Barrick declined due to the weakness in gold, but the selling appears to have been exacerbated by the issues related to Pascua-Lama.  By comparison, the largest market cap gold miner in Canada, Goldcorp Inc. (TSX: G), was relatively issue free and saw its stock drop by as much as 50% from its 52-week high.

A more diversified approach

In a sector as bad as gold, there was nowhere for investors to hide.  Now however, gold stocks may be primed for a recovery.  So what’s the best way to play the potential upside and at the same time diversify your risk?

One simple answer may be to buy a gold mining ETF that holds multiple miners such as the iShares S&P/TSX Global Gold Index Fund (TSX: XGD).  The two largest holdings, accounting for 29% of the fund’s assets, are the aforementioned Barrick and Goldcorp.  The fund has been down nearly 57% from its 52-week high over the last year, meaning investors were even worse off than just buying Goldcorp at its high.

A recovery in the gold price would certainly be positively reflected in the price of this fund, however, it is still very reliant on the fortunes and performance of individual miners.

Mining service providers

This brings me to potentially my favorite way to play gold.  Companies that provide services to a diverse group of miners.  This helps to alleviate the risk associated with individual mine exploration.  One such play is Major Drilling (TSX: MDI).

As I mentioned before, no stocks were spared the carnage in this space and Major Drilling was no exception.  The company’s shares were down by as much as 46% from their 52-week high.

Major Drilling provides contract drilling services to mining and mineral exploration companies worldwide.  The company recently reported its results for its fourth quarter ended April 30 and it was not a pretty site.  Revenue was down 43% to $135.5 million and net income fell nearly 93% to $2.2 million. However, the company’s balance sheet is conservatively managed with net cash (net of debt) of $38.7 million and despite the poor performance, net cash increased by $8.6 million during the quarter.

The company’s revenue is currently tied very closely to gold and copper as drilling for these metals accounted for 68% of revenue in the fourth quarter.  However, that is changing as the company continues to diversify its services including growth in the U.S. shale market and an entrance into the Alberta oil sands.  The company is also planning to enter the Brazilian market and continue to exploit opportunities in underground drilling.

Senior and intermediate miners, that will have an easier time financing projects through the downturn, made up 79% of revenues for Major Drilling.  In addition, the company’s highly variable cost structure has allowed it to continue to generate positive cash flows even during this trying time.  Management expects continued delays and cancellations in the near-term with no real clarity until the industry’s next round of annual budgets are released.

Final thoughts

The ride may still be a little rough for gold in the near-term and the recent bump higher may only be temporary.  However, given the devastation in the sector, it may be worth putting some money to work in the right areas.

Once the miners and financiers are more comfortable that the price of gold has at least stabilized, the low mining cost projects should move forward and Major Drilling should benefit.  In addition, the diversification into the oil sands was very timely as oil prices have surged, helping to continue to drive projects in this oil rich area of Canada and giving Major Drilling investors some additional diversity.

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Fool contributor Alex Gray has no position in any stocks mentioned at this time.  The Motley Fool does not own any stocks mentioned at this time.        

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

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