Gold is on hold awaiting the rate outlook. In the first month of 2024, gold fluctuated in a narrow range, reaching a low of $2,006 an ounce on January 17, as the market reassessed the chances of a US Federal Reserve (Fed) cut in March. The implied probability of a rate cut in March fell from 81.5% at the beginning of the year to 35% at the end of January. Gold found support above $2,000 an ounce, even as the US dollar strengthened (the DXY1 index rose by 1.92%) and yields rose, rebounding from its lows to close at $2,039.52 an ounce on January 31, a decline of $23.36 or 1.14% for the month.
Little love for gold (and even less for miners)
Gold remained little moved in February, closing below $2,000 an ounce on February 13 and 14 before rebounding and holding above this level for the rest of the month. Gold ultimately settled at $2,044 an ounce on February 29, up 0.23% on the month. US core and headline Consumer Price Index (CPI) readings for January came in above consensus forecasts, postponing the likelihood of a US Federal Reserve (Fed) rate cut later in the month. year and putting pressure on gold in the middle of the month. Gold subsequently found support to set an average closing price of $2,029 per ounce this year, not bad considering that, over the same period, the US dollar (as measured by the DXY1 index) rose by 2.8% and demand for investment in physical gold (measured by holdings in gold-backed ETFs) fell 3.7%. While physical gold was seemingly underappreciated last month, gold stocks performed disappointingly. The index NYSE Arca Gold Miners (GDMNTR)2 and the MVIS Global Juniors Gold Miners Index (MVGDXJTR)3 fell 6.10% and 6.84% respectively in February, further widening the already significant valuation gap against the metal. The first few days of March brought some relief to gold equity investors, however, with gold mining stocks sharply outperforming physical gold as gold hit new all-time highs. It could be the start of a mean regression trend that sees gold mining stocks once again show their leverage relative to the gold price and outperform physical gold when gold prices are in increase. For reference, GDMNTR would need to more than double from current levels to reach its August 2011 peak, so there still appears to be a fair amount of potential for escape just based on historical performance.
The gold miners are really giving it their all
Last month we attended the BMO Global Metals, Mining and Critical Minerals Conference. We met with executives from more than 40 gold and precious metals companies. This conference offers a great opportunity to take the pulse of the industry, spot trends and themes, receive updates from individual companies and potentially discover new investment ideas. Here are some of our main ones conclusions:
- Location, location, location. It’s no secret that mining companies face many risks related to the regions in which they operate. However, it is important (and necessary if you want to invest in the sector) to distinguish between broader jurisdictional risk and risks specific to mining operations. We encountered companies with projects in regions/jurisdictions considered geopolitically risky – including countries such as Peru, Ecuador, Guyana, Nicaragua, Papua New Guinea and Ethiopia – but with managements that appear to enjoy operational stability in these locations. Côte d’Ivoire and Guinea appear to be considered pockets of stability in the complex West African region. West Africa, a challenging jurisdiction due to the geopolitical landscape, continues to be one of the best regions to discover and develop gold resources from an exploration, permitting, labor and capital efficiency perspective. Although companies seem more cautious about the changes and developments taking place in countries such as Argentina, Colombia and Mexico, the overall outlook regarding mine management and investments appears to be optimistic.
- Set expectations. Companies are well aware of the importance of achieving their announced goals. We communicated the urgent need to develop detailed methodologies that enable companies to do this successfully, given the complexity and numerous variables involved in forecasting production, operating and capital costs for operations and projects. Companies with advanced and conservative guidance-setting processes should benefit from the significantly higher valuation multiples that come from meeting or exceeding expectations.
- Refocus on cost control. Following a wave of inflation that has significantly increased operating and capital costs over the past two years (mostly outside the control of mining companies), there is a renewed focus on implementing initiatives control and cost reduction. We also reportedly hear that Australian jobs inflation is easing after 2 years. It appears that inflationary pressures have eased and that, combined with companies’ efforts to reduce costs, average industry costs are expected to remain around current levels.
- Free cash flow abounds. While rising production costs have put pressure on margins, at current gold prices companies are generating plenty of cash. For example, one of our mid-tier holdings, with a market capitalization of $1.5 billion, holds over $640 million in cash and zero debt. The company pays a dividend and is looking to make acquisitions to put cash to work. However, with operating cash flow of more than $400 million per year, the company looks set to continue building its financial reserves. This bodes well for dividend-seeking investors, as companies are committed to establishing sustainable base dividends with the possibility of bonus or special dividends should free cash flow expand.
- Acquisitions come with challenges. At both the asset and company levels, integrating new projects and operations brings risks and challenges. Acquiring companies must provide updated strategies, restructuring plans, operational and financial forecasts. This increases the risks for these companies and creates uncertainty in the markets. Companies must be able to manage these risks in their pursuit of growth and value creation. In the long run, acquisitions will pay off for stronger management teams. However, in the short term, these acquisitions can create downward pressure on their shares.
The gold mining industry is undoubtedly avery demanding activity. We spent most of our time at the conference discussing with executives their strategies and how they are addressing what we believe are the biggest risks facing any company. We are encouraged to see gold mining companies focus their efforts on de-risking their businesses, reducing costs, improving shareholder returns and pursuing disciplined growth with the participation, support and benefit of Host countries and communities, in an environmentally responsible and ethical manner.
