On June 14th, the Federal Reserve’s monetary policy committee said Wednesday it would pause its historic rate-hiking campaign, as it waits for the effects to trickle further through the economy.
According to Viraj Patel, the Federal Reserve has never paused rate hikes and then accelerated them.
But just days after pausing, central bank officials are calling for more increases.
San Francisco Fed chief Mary Daly told Reuters two more U.S. interest-rate hikes this year is a “very reasonable” projection, but it is better to move more slowly and carefully than before.
For investors, this leaves us asking an important question…
Are we at the end of the rate hike cycle, and potentially looking at the next rate cut cycle?
Or, to quote the famous Coca-Cola slogan, was this our first “pause that refreshes?”
In the meantime, the gold story is coming back to the forefront as some investors seek safety from the threat of inflation and market volatility.
Some analysts are predicting gold to retreat (or even drop below) the $1,900 support line while others are forecasting “This Could Be the Last Opportunity to Buy Gold Below $2000”
I’m personally a believer in Goldman’s Commodity Supercycle thesis, and bullish on the long-term outlook for gold prices.
But in my opinion, the more interesting debate isn’t whether or not gold is going to go up or down, but the potential ways to seek profits from what happens next.
Here’s why…
March was the first month of net inflows into gold ETFs in nearly a year, while the volume of bullish options trades tied to the funds has approached record levels.
There has also been a similar increase in interest in CME Group gold futures and options tied to them, including deep “out of the money” options, which would only pay out if the gold price hits new all-time highs.
Further, the trend for shorter-dated options, specifically weekly options, has soared. Year to date, weekly gold options account for 22% of total volume, the highest in history.
Overall gold options average daily volume of 67,427 contracts is now the highest ever as well.
Personally, if I’m going to speculate on the price of gold, I would rather not trade futures or options.
That leaves me with pretty much two options if I’m looking for asymmetric upside potential at a discounted price… junior mining stocks and early-stage royalty & streaming companies.
Today, we’ll be taking an inside look at what’s going on with mining stocks.
-Equifund Publishing
Why Gold Mining Stocks Could Be Undervalued (and why that could change in the near future)
For years now, the stock market hasn’t been kind to value investors in search of a discount…
With one notable exception: mining stocks.
Investing in the stocks of companies that trade below their book value—the accounting value of assets such as factories, inventory, and real estate, minus liabilities—is a strategy first popularized by Ben Graham in the 1930s.
But few companies of any significant size trade below book value today.
Consequently, Barbee’s stocks are often the smallest, most overlooked ones that big institutional investors ignore.
The bulk of his portfolio is currently in mining, energy, and timber stocks—companies with plenty of hard assets.
Barbee likes miners with “hidden assets” … as they can have what he calls asymmetric returns relative to the price of gold bullion—more upside and hopefully less down as the market eventually recognizes the hidden value.
For reference, I first started studying the mining industry back in ~2021 when we launched a Regulation Crowdfunding offering for Durango Gold – which, based on our knowledge, was the very first junior mining company to do so.
Prior to this, I was most certainly not a gold bull, nor a fan of junior mining deals, and I did not do well in my intro-level geology course (which we called “rocks for jocks”) when I was in college
But once I started to get past the dense technical jargon about mineral deposits, the economic case for “why mining” in general, became pretty clear to me.
No miner is the same, but even those that have little coal exposure are greatly unloved by investors: they trade at half the valuation levels of other industrial companies, despite having a superior return on invested capital (ROIC), 35% higher dividends and generate one and a half times more free cash flow.
Even though the big global miners outperform the general market on just about every financial metric, the MSCI Metals and Mining Index has significantly underperformed for many years. It seems like there is always a stick to beat a miner with.
While I initially dismissed this as investors simply preferring tech stocks hype – and at the time, valuing growth more than cash flow – I found more confirmation of this pricing anomaly (chart below shows data as of Dec 31, 2021).
“There is currently a disconnect between where metals prices are and how mining company share prices are trading, and I believe there are a few explanations.
First, the broader economy has seen such a bull market that investors continue to chase returns elsewhere.
Second, there is a lack of conviction among investors in the sustainability of these prices.
Third, there is a larger question of relevance from the perspective of investors seeking exposure to precious metals.”
At the time, I believed that if our macroeconomic thesis regarding the importance of domestic mineral production was correct, we could see these historically undervalued assets appreciate in the coming years ahead.
Chart shows the performance of mining stocks (XAU) relative to equity markets (S&P 500) and illustrates how low gold mining stocks are valued relative to the broader equity market. Even if there has been a stabilization of the ratio since 2015, the current ratio is one-fifth of the 2011 peak. Source: Incrementum, In Gold We Trust: 2022
This underperformance of mining stocks becomes particularly clear if we make an even longer-term comparison. The oldest available gold mining index, the Barron’s Gold Mining Index (BGMI); at the time, it was trading at 0.50x, miles below the long-term median of 1.43x.
Furthermore, in an economic environment where cash flow is king – and commodities are booming – there’s simply no ignoring the facts; within the commodities sector, no other subsector is currently showing higher margins than precious metals producers.
The global all-in-sustaining costs (AISC) of gold producers increased in the previous year, in line with general inflation.
According to the World Gold Council, AISC was $1,007 in Q4/2020, and a year later they were at $1,129, an increase of 12.2%. In 2022, AISC reached a new high of $1,276 per ounce, an 18% increase.
The Commodity sector as a whole generated negative free cash flows in 2012–2016. Even after that, free cash flow was marginal, and limited to low-cost companies; but by spring 2021 at the latest, gold and silver miners became true cash flow monsters.
In 2022, profitability suffered from high inflation, yet total free cash flow was around $24 billion.
I’ve said this before and I’ll say it again. The secret to outperformance is to be both contrarian and right.
But eventually, if you want to sell your position for a profit, the market needs to agree with you and value it accordingly.
Even though we had a brief window of enthusiasm for miners, it doesn’t seem the market believes the bull market thesis and continues to discount miners.
Although the gold price has been trading close to new all-time highs, and miners have the highest cash levels in history…
The HUI Gold Index – a modified equal dollar-weighted index of companies involved in gold mining – is trading more than 50% below its all-time high of 635 in September 2011.
No promises, but this could potentially represent an asymmetric payoff profile if investors decide to “reprice” mining stocks.
More specifically, these prices could appear if the M&A cycle heats up.
“We expect that producers’ bubbling cash flows will lead them to replenish their shrinking reserves through acquisitions and mergers.
The biggest beneficiaries of this development will be junior producers, fully funded developers, and explorers with world-class discoveries in Tier 1 regions.”
Investors in exploration companies should realize that a major mining company, considering the buyout of a junior, is much less likely to be interested if the land package is an unconsolidated mix of patented and unpatented mining claims.
That also means that some of the more interesting projects today have been underexplored due to fragmented claim status and a lack of historical data.
“Consolidation is the key to unlocking shareholder value in a mineral land package.
[Majors] seem to lose interest fairly quickly because if the ground is not consolidated, then they’re limited on where they can explore.
The bigger companies especially don’t like to spend a lot of time and money negotiating deals with people and consolidating it themselves.
And the consolidation of the historic data is also a key to increasing the value of a project”
Depending on where the claims are, differing ownership can become troublesome for exploration companies wanting to develop consolidated land packages; especially when the goal is to sell the complete package to a major mining company following value-added exploration on the properties.
And to this end, we see enormous opportunity in the State of Nevada.
Nevada: America’s Real Golden State
Thanks to the California gold rush of 1848, California earned the nickname “The El Dorado State” – which translates as “the Golden One.”
In 1968, California’s legislative body made “The Golden State” an official nickname based on the state’s long association with gold.
However, the real “Golden State” in America – based on gold production – is the State of Nevada. As an example, in 2020, Nevada led the nation with 4,632,690 oz – 74% of the United States’ total output.
According to the United States Geological Survey (USGS), this means Nevada is the 4th largest gold producer in the world, behind China, Australia, and Russia, and represents 4.4% of the world’s production.
Furthermore, USGS data shows Nevada has proven and probable gold reserves in excess of 54 million ounces; at ~$1,900/oz, this represents $102.6 billion in gold.
Although this represents only a tiny portion of the global gold reserves, Nevada’s natural resources quite literally made Nevada the state it is today.
Nevada contains one of the single richest deposits of gold on the planet.
Between 1835 and 2018, three main geological formations – known as “trends” – have produced a combined 170 million ounces of gold.
Even though Nevada has undergone several cycles of exploration and development since the mid-1800s, explorers still see potential for more ore to be found, especially at depth.
This can be attributed to the fact that most of the low hanging fruit – the shallow, multi-million-ounce oxide deposits – have been discovered and mined out. Nowadays, new discoveries are coming from deeper deposits that are more difficult to find.
New discoveries, such as Nevada Gold Mine’s recent discovery of the huge 15 million-ounce Goldrush deposit, tend to result from rethinking the geology of previously mined areas, and drilling underneath the near surface mineralization.
Therefore, many explorers in Nevada are currently going deeper to find high-grade, refractory deposits.
There are also companies focusing on underexplored areas of Nevada, in hopes of finding the next major discovery.
According to James Buskard, President and CEO of Nevada Exploration: These valley basins have been under-explored due to a historic lack of specialized undercover exploration tools.
A renewed interest in mining – plus new innovations in mining technology – could prove to be a boon to the sector.
However, Nevada’s mineral endowment isn’t limited to precious metals…
Over 20 minerals are mined in Nevada, including lithium and vanadium – both of which are essential to the expansion of renewable sources of energy and emerging energy storage technologies – as well as copper, iron, molybdenum, gypsum, limestone, sand and gravel.
All told, in 2020, the annual value of minerals produced in the state totaled nearly $9.5 billion.
We are witnessing an exponential increase in the demand for Nevada’s minerals including copper, nickel, gold, silver and lithium as the economy moves towards electrification and with the transformation of our energy sector.
The demand for these minerals will [potentially] boom as the world recovers from the pandemic, infrastructure projects take off, along with the manufacturing of technologically advanced machinery and equipment that rely on these metals.
Majors worldwide continue to drive exploration investment, and Nevada has, again, led that trend in 2022.
At least four material acquisitions took place in Nevada in 2022: Orla Mining acquired Gold Standard Ventures; Centerra Gold acquired the Gemfield project from Waterton Nevada Splitter; Calibre Mining acquired Fiore Gold, and AngloGold Ashanti acquired Corvus Gold.
As the competition for funding is fierce, Derek Macpherson, president and CEO of Gold79, sees M&A activity as beneficial for actors in the state to unlock its true geological potential:
I think we need to see M&As as there are about 50 of us there. There needs to be consolidation as it is difficult to fund all these firms from the same pool of capital in public markets. This will lead to higher quality assets being explored and better attribution of capital.
For investors looking to capture potential gains from the gold markets, junior mining companies arguably provide the highest potential rewards.
However, they also come with extraordinary operational risk. Not only do they have to bear the upfront cost of finding a workable mineral asset, they have to extract those minerals before they can generate revenue (let alone profit).
But what if there was a way to decrease one of the most controllable forms of risk…
The mining company is unable to execute on their business plan, because they run out of capital – and are potentially unable to secure additional capital – due to predatory financing arrangements.
That’s exactly why alternative financing agreements – like Golden Cash Flow Contracts – may provide a “win-win” solution for junior mining companies and investors.
In exchange for a non-dilutive source of capital today, the mining company agrees to give investors a long-term, annuity-like repayment with two forms of downside protection… and a small chance for significant potential upside.
