Gold is historically seen in some quarters as a protected haven in occasions of geopolitical volatility. I feel the truth is a little more sophisticated than that however with the gold price not too long ago hitting all-time highs, clearing the yellow metallic has been attracting loads of patrons.

The London market contains a number of gold miners together with numerous penny shares. On condition that the gold price has been surging, ought I so as to add a few of these penny shares to my portfolio or maybe hovering former penny shares?

The economics of gold – and gold mining

Earlier than digging into specifics, let me talk about how the gold enterprise works. As a treasured metallic with finite availability, the gold market is cyclical.

When demand is excessive, for instance as a result of nervous traders search a retailer of worth, cash piles in. As demand more and more outstrips provide, the price rises.

In some unspecified time in the future the market tops and sellers outnumber patrons. The price then begins falling and ultimately (possibly a few years later) reaches a backside, when the method begins once more.

Crucially although, it isn’t apparent that the market is at a backside or a high on the time – that solely turns into clear looking back.

Mining is initially extremely speculative and capital intensive. Miners spend plenty of cash prospecting and generally constructing mines. That may be cash down the drain. However a viable mine can produce nice rewards.

The marginal manufacturing price might be low, so surging sale costs can feed nearly on to the underside line. In different phrases, earnings can soar when costs are excessive.

Investing in miners isn’t for the faint-hearted

In funding phrases, prospecting might be high-risk, high-reward. That’s the case with many prospecting penny shares. They need to elevate cash to fund a single potential venture. The potential rewards could possibly be excessive — however there’s a massive focus of danger.

The business economics nonetheless apply to large diversified miners like BHP. Fastened prices might be excessive, prospecting is dear and metals are a cyclical market, which means doubtlessly massive swings in sale costs over time.

Crucially although, they’ve far much less focus danger than the everyday mining penny share.

Two which have soared!

That explains why I’ve no plans to spend money on gold-focused shares that promote for pennies, together with Serabi Gold (LSE: SRB) and Metals Exploration.

A yr in the past, each had been penny shares with market capitalisations of below £100m. Whereas they nonetheless commerce for pennies, these two shares have soared 164% and 116% respectively in 12 months, giving every a nine-figure market-cap. That reveals what a hovering gold price can do.

Serabi’s earnings have jumped accordingly. Full-year figures usually are not but accessible, however its gold output final yr was up 13%. Add to that greater manufacturing a really sturdy gold price and the revenue uplift needs to be substantial.

If gold costs keep excessive, this yr could possibly be even higher, as Serabi expects to ramp up manufacturing considerably once more.

However whereas Metals Exploration has not less than some geographic diversification, Serabi is all-in on one market (Brazil). Each firms give attention to one metallic: gold.

Even other than the danger of the gold market turning right into a downward part of its cycle, that stage of focus continues to be far too dangerous for me.