About a week ago, the investing world was aghast.
It learned Warren Buffett’s Berkshire Hathaway bought a stake in gold miner Barrick Gold Corp. (NYSE: GOLD) at some point last quarter.
“How could he?” cried amateur and professional investors alike.
After all, Buffett has basically said gold is dumb.
But so what? People buy dumb things all the time.
Just because it’s Warren Buffett means he can’t do it too?
What if he buys a company that produces dumb stuff at a profit? Is that OK?
That isn’t dumb to me.
No, the problem with this story isn’t that Buffett’s company bought a gold stock. It’s that he bought the wrong one.
I’ll show you…
Trading the Gold Bull Market
To be clear, I have no problem with Barrick Gold.
CEO Mark Bristow is one of the few in the mining industry who tells you what he’s going to do, then does it.
And if gold prices continue to rise, I don’t worry he will run out and make a stupid, expensive acquisition. That’s what lots of CEOs did during the last gold bull market.
For you and me, though, there are better ways to maximize our profits in a gold bull market.
You just have to think smaller.
Generating Outsized Returns
Let’s assess the potential return on Buffett’s buy.
We don’t know the date when Berkshire bought Barrick shares during the quarter. But we know he and his colleagues are great investors.
So, let’s assume they bought the shares at the low closing price of the quarter. That was April 1.
If they bought on April 1, they are now up 56% (through August 26).
That’s solid for less than five months. The gold price was only up 23% during this time.
But it doesn’t compare to the returns of some of Barrick’s peers … most notably the smaller ones.
These Gold Companies Beat Buffett’s Pick
Barrick’s market cap was $33.6 billion at the start of this stretch. The best performer in the VanEck Vectors Gold Miners ETF (NYSE: GDX) was one-fortieth that size.
And its return was more than four times that of Barrick.
The three smallest members of the exchange-traded fund (ETF) generated three-and-a-half times the returns of the three largest. They averaged 167% returns versus 48% for their larger peers.
When a sector is moving in the right direction, you should always consider the best small names. They simply have more room to run.
We saw that here. And we see that in every sector.
It’s a simple concept, but it can be lucrative.
Editor, Profit Line
P.S. The stocks profiled in this article are known as small caps.
We own a small-cap gold producer in our Profit Line investment service. I can’t tell you exact numbers, but since April it rose a similar amount as the small-cap stocks referenced in this article.
Our strategy has been paying off lately. And in the past week, we sold two stocks for profits of 280% and 118%.