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How Do I Know if Investment Offers in Gold Stocks are Legit?

How Do I Know if Investment Offers in Gold Stocks are Legit?

When the price of gold bullion goes up, so does interest in gold investments. A flood of marketing is unleashed throughout social media sites and the Internet in general about gold and gold stocks. But some of the golden opportunities being hailed actually have little value, and others are simply frauds.

The Commodity Futures Trading Commission (CFTC) has brought legal action against various precious metals firms engaged in schemes involving gold, silver and other precious metals, including a Florida firm that bilked investors out of more than $23 million.

Clearly, there are prudent and not-so-prudent ways of taking advantage of gold investments. Many gold scams involve stocks connected with gold mining and exploration companies. The problem is that the stock’s value is often tied to the company’s gold reserves, which are difficult to estimate and verify. Stock promoters like to tout the potential value of a gold reserve, and some statements can be deliberately misleading. In 2010, for example, the SEC took legal action against a mining company based in Florida regarding false press releases and misinformation related in part to an Ecuador mining operation. The public information claimed gold reserves worth more than $1 billion, but the SEC said there was no way to know the actual worth “without further detailed exploration.”

Some pitches to be wary of:

Inflated values or predictions of swift and exponential growth.  This is usually based on gold reserves, the size and existence of which, as we’ve said, are almost impossible to verify. One company claimed that its mine held “approximately 2.14 million ounces of gold equivalent resources,” and had an estimated market value of over $2 billion. Based on these reserves, it claimed an investment “Could turn $10,000 into $384,600.” Definitely in the “too good to be true” category.

References to being a “buyout target.”  Claiming reserves (based on what?) at more than $112 billion, one company declared it was a “Prime Buyout Target” with a buyout price 15 to 35 times its current value, which was around a dollar.

Gold prices tied to stock performance.  Stock prices rise or fall for many reasons, such as overall market conditions, sector performance and company earnings. A rise in gold prices does not guarantee a rise in the price of a gold company’s stock—there might be no correlation.

A hedge against inflation or an economic meltdown.  While some investors might hold gold as a hedge against economic uncertainty, owning a gold stock does not automatically serve that function. But this line is often used as a scare tactic to push an investor for a quick decision.

Touting proximity to an existing reserve.   A company claimed its mining property COULD BE worth “billions “ based on the success of its neighbors.” Without more information, that’s only idle speculation.

A name change. Some companies didn’t start out doing gold.  One company currently claiming to be in gold mining and exploration was originally incorporated to provide golfing opportunities on private courses for non-members.  Another’s original focus was to establish health spas in urban areas. Another’s plan was to develop, manufacture and sell commercial feed to nurture the Chinese mitten-handed crab. And these are gold experts? Name changes are reported through SEC Form 8-K, which you can find by using the SEC’s EDGAR database.

Fool’s Gold for lunch.  Be wary of “free lunch” programs that purport to provide educational information about gold investing. In June 2010, the SEC charged six individuals with running a Ponzi scheme that bilked more than 3,000 investors out of $300 million. The fraudsters, none of whom were registered to sell securities, claimed to represent an independent financial education firm that had discovered a way to earn up to 36 percent annual returns by investing in mining investments that were “fully collateralized by gold.” Rather than invest the money, the firm’s salesmen used the assets on lavish home renovations, mortgage payments for members of their extended family and the purchase of a luxury fishing resort in South America.

Also common to gold stock scams:

•    That profits in gold are “easy.”

•    Headlines from respected financial news sources regarding gold and taken out of context.

•    Mentioning names of investors or investment institutions that provide an aura of credibility.

•    Statements about how much easier it is for lower-priced gold stocks to skyrocket in value than higher-priced stocks.

•    Pressing to immediately invest.

What can I do to avoid stock scams?

Don’t invest before you investigate.  Never solely rely on information from an unsolicited fax or email. Companies and promoters often make exaggerated claims about new products, lucrative contracts, or the company’s revenue, profits, or future stock price. Be wary of claims about significant mineral reserves or mining operations in countries far removed from the U.S. that are hard to verify through independent research.

Ask: “Why me?”  So, why would a complete stranger tell you about a really great investment? The answer: the opportunity doesn’t exist. In many email, fax and online scams, those pushing the stock are corporate insiders, paid promoters or substantial shareholders who stand to profit handsomely if the company’s stock price goes up.

Read a company’s SEC filings, if available.  Most public companies file reports with the SEC. Check the SEC’s EDGAR database to find out whether the company does so. Read the reports and verify any information you have heard about the company. And remember: just because a company has registered its securities or has filed reports with the SEC, that doesn’t mean it’s a good investment.

What are some gold investment options?

While it may be tempting to invest in a single stock, it’s risky to put all your investments in one place. Investing through a mutual fund or exchange traded fund (ETF) that focuses on gold companies or gold itself can help spread and potentially lower your risk. Take the time to research fees and other expenses. Review the underlying securities that comprise a given fund. Go to the issuer’s website, review the latest report about the fund’s major holdings or, in the case of an ETF, the exchange on which the ETF trades. Research the fund’s manager or management team and read the prospectus carefully. You might also consider the help of an investment professional.

If you are considering a mutual fund that focuses on gold, be aware that most gold mutual funds primarily hold mining stocks, many international. But some also hold physical gold. But mutual funds don’t let investors possess physical gold.

If you are considering investing in an ETF that focuses on gold, understand its structure, including whether it uses futures strategies—and whether or not it holds the physical gold, invests in gold futures contracts, or tracks a gold-related index. Be aware that ETFs backed by physical gold are not the same as a direct gold investment. Some ETFs backed by physical gold allow individual investors to redeem shares for bullion, but those may only allow physical redemptions under limited circumstances. So while they may be effective at offering exposure to gold prices, most are not an efficient way to obtain an ownership interest in physical gold. So, if you are investing in a physical gold ETF, make sure you understand your redemption rights. Depending on its legal structure, a gold commodity ETF can be subject to varying tax treatments. Be sure to check with your tax advisor about the consequences of investing in a gold commodity ETF.

If you are thinking about investing directly in bullion or gold coins, similarly research your options. For a basic how-to overview, questions to ask and additional resources, read the Federal Trade Commission’s Investing in Bullion and Bullion Coins.  Investors should be aware that while some gold promoters and dealers deliver what they promise, others don’t. Also, verify that a ready market exists to liquidate personal holdings of bullion and coins at current market prices and the related transaction costs.

Finally, know that while legitimate gold and ETF investments may be an acceptable diversification strategy. These investments can be quite volatile. A heavy concentration of gold investments can leave you at risk of losing a substantial percentage of your investment.

What are some of the best  resources for investigating investment options?

•    Investor Alert, Stock Spams and Scams

•    FINRA BrokerCheck

•    Commodity Futures Trading Commission Fraud Advisory, Precious Metals Fraud

•    SEC Litigation Release, SEC Brings Action Against Purported Florida Mining Company and Its President for Fraud

•    SEC Release, SEC Charges Perpetrators of $300 Million Ponzi Scheme Involving Purported Gold Mining Investments

•    Federal Trade Commission Consumer Alert, Investing in Bullion and Bullion Coins

•    Federal Trade Commission Consumer Alert, Investing in Gold? What’s the Rush?