Gold miners outperformed gold in last years: Veritas

Key Concepts

• Leverage in Gold Mining Stocks: Mining stocks tend to outperform gold bullion during price increases due to their operational leverage.
• EVA & PE Multiples: Preferred valuation methods for gold companies, focusing on economic value added and price-to-earnings ratios.
• Reserves vs. Resources: Understanding the distinction between proven reserves, measured resources, and indicated resources in gold valuation.
• Geopolitical Influence on Gold: Current geopolitical instability and concerns about the US dollar are driving gold prices upward.
• Central Bank Gold Purchases: Increased gold buying by central banks, coupled with selling of US Treasury bonds, is impacting the gold market.
• Franco Nevada (FNV): Potential benefit from the reopening of the First Quantum mine in Panama.
• Barrick Gold (ABX): Anticipated IPO of Nevada Gold Mines (a Barrick subsidiary) and plans to improve Nevada operations.
• Wheaton Precious Metals (WPM): Strong exposure to silver price increases, making it an attractive investment.

Gold Mining Stocks & the Current Gold Rally

This discussion focuses on the recent surge in gold prices and the outperformance of gold mining stocks compared to bullion. Martin Praier, a materials analyst at Veritas Investment, explains that mining stocks exhibit leverage to the gold price, meaning their profits increase at a faster rate than the gold price itself – potentially doubling with a 50% increase in gold.

Valuation of Gold Mining Companies

Traditionally, gold stocks were valued based on their gold reserves (the amount of gold confirmed to be recoverable). However, Praier prefers using Economic Value Added (EVA) and Price-to-Earnings (PE) multiples, alongside historical trading data. He clarifies that reserves represent only a portion of the total gold present, with “measured” and “indicated resources” also needing consideration, making reserve-based valuation potentially misleading.

Technical Terms:

• EVA (Economic Value Added): A measure of a company’s financial performance based on the residual wealth calculated by deducting the cost of capital from the net operating profit after taxes.
• PE Multiple (Price-to-Earnings Ratio): A valuation ratio of a company’s stock price to the earnings per share.
• Reserves: Quantities of gold that are economically and legally extractable at the time of determination.
• Measured Resources: Resources with a high level of confidence in their existence, quantity, and grade.
• Indicated Resources: Resources with a reasonable level of confidence in their existence, quantity, and grade.

Drivers of the Current Gold Rally

Praier attributes the current gold rally to unprecedented geopolitical issues, specifically referencing concerns surrounding former President Trump’s actions, including attacks on the Federal Reserve Chairman and undermining the NATO alliance. These events are eroding confidence in the US dollar. Furthermore, central banks are actively increasing their gold holdings while simultaneously reducing their positions in US Treasury bonds. He highlights the significant size of the US government bond market (15 times larger than the gold market), emphasizing that even a small shift in investment from bonds to gold can have a substantial impact on prices.

Data Point: The US government bond market is 15 times larger than the gold market.

Specific Stock Analysis & Investment Opportunities

The conversation then shifts to specific stock recommendations:

• Franco Nevada (FNV): Praier anticipates a positive impact on Franco Nevada from the potential reopening of the First Quantum mine in Panama. This mine represents approximately 5% of Panama’s GDP, making its resumption crucial for the country’s economy.
• Barrick Gold (ABX): Praier believes Barrick Gold is poised for growth due to a planned Initial Public Offering (IPO) of approximately 15-20% of Nevada Gold Mines (a Barrick subsidiary, Pueblo Viejo is also mentioned). This IPO will provide a clearer valuation of Barrick’s most valuable asset. He also notes that Barrick needs to address increasing costs (up 45% in the last five years) and declining production in Nevada, and will need to present a plan for improvement.
• Wheaton Precious Metals (WPM): Praier upgraded WPM in November due to the rapid increase in silver prices. He notes that silver now accounts for approximately 50% of WPM’s revenue, making it a key beneficiary of the silver rally. He points out that silver’s price increase has outpaced gold’s, shifting the revenue ratio.

Data Point: Silver currently represents approximately 50% of Wheaton Precious Metals’ revenue.

Analyst Challenges & Market Dynamics

Praier acknowledges the difficulty of accurately predicting gold prices in the current volatile environment, stating he has already revised his price targets and may need to do so again. He emphasizes the importance of understanding the underlying reasons for gold’s increase, namely geopolitical instability and shifts in central bank behavior.

Quote: “It’s very difficult to predict where uh gold will will end at the at the end of the year… I think what is easy to understand is why gold is increasing.” – Martin Praier

Disclosure

Praier confirms he and his family do not hold shares in Franco Nevada or Barrick Gold, adhering to regulatory restrictions.

Conclusion

The discussion highlights the current bullish outlook for gold and, more specifically, gold mining stocks. The leverage inherent in these stocks, coupled with geopolitical instability and central bank activity, creates a favorable environment for investment. Franco Nevada, Barrick Gold (particularly with the anticipated Nevada Gold Mines IPO), and Wheaton Precious Metals are identified as potentially attractive opportunities, but investors should carefully consider the evolving market dynamics and the challenges of accurately predicting gold prices. Valuation based on EVA and PE multiples, rather than solely on reserves, is recommended for a more comprehensive assessment of these companies.