The price of gold surged over a record US$2,100/t.oz in March, following an average increase of more than 20% since 2011, and is close to topping US$2,200.

Yet, gold mining stocks have declined more than 50% since 2011. Newmont Mining, the largest gold miner in the world, is down 60% from it’s high in 2022.

The implied gold price — the price at which an investor recover’s the market cap of the company at prevailing gold prices — is now estimated to be a 50% discount from the current gold price.

“That’s the steepest discount I’ve seen and I’ve been doing this for 25 years”

— John Hathaway, senior portfolio manager, Sprott Asset Management

Something has to break: either the price of gold drops or the price of the miners will dramatically rise.

Gold rush

Firstly, why are gold prices rising?

The fundamentals are largely unchanged from our analysis last year “The Great Gold Rush of 2023“, including:

• the biggest driving force behind the rise in the price of gold is central banks, with net purchases of 1,037t in 2023, almost matching the 2022 record, falling just 45t short. And with central bank purchases continuing in January 2024, expectations are high that the trend will continue for the rest of the year

• gold jewellery demand is increased in 2023, from 2,089t to 2,093t. In value terms, this translates to 8% growth and a record US$131 billion. China is the main driver with consumption reaching 148t in Q4 (+17% year-on-year), lifting the full-year total to 630t (+10% year-on-year)
• despite two years of modest supply increases (3% y/y in 2023) from gold miners, which account for about 75% of annual gold supply, supply appears to have peaked (for now) in 2019. And, despite the record prices of gold, recycled gold supply rose 9%in 2023, approximately 30% below the all-time high seen in 2009
• gold is historically used as a hedge against inflation and a stable store of value as currencies depreciate, and with US core inflation at 3.9% in December 2023, many investors remain wary that we may yet see another wave of high inflation
  
  However, the rise in gold form 2022, coincided with rising interest rates and a strong US dollar, both of which often work as a counter to gold’s traditional use as a safe haven (gold doesn’t pay interest and a strong dollar can act as a haven in it’s own right)
  
  Bets that the US Federal Reserve will lower rates has both weakened the US dollar and strengthen gold

So, if the price of gold is rising, despite high interest rates — why not miners?

And it’s not just markets. From our own observations and discussions at this year’s PDAC, the world’s leading mining and mineral convention, sentiment was very quiet.

Tech and Crypto

We are skeptical of the argument that investment in crypto, touted as the future alternative to fiat currencies, is displacing money from the gold market as the younger generation instead focus their investments on Bitcoin, Dogecoin, etc.

Instead, crypto and tech is displacing investment across almost all mining, energy and many other markets.

The so-called “Magnificent Seven” tech stocks (Nvidia, Microsoft, Apple, Amazon, Alphabet, Tesla, and Meta) increased 75% in 2023, while the other 493 companies in the S&P500 were up only 12%. 

It’s also part of a trend that gold miners — all miners — are struggling with among the young generation: a reluctance to invest in mining due to it’s historic environmental and social reputation (whether deserved, or not), as well as volatility over the last 10 years.

Yet, despite these headwinds, the gold price appears to be trying to break it’s historical negative correlation with interest rates. 

If the gold price is not overvalued and set for a fall, then it would be expected that gold miners should also be able to push back against these financial headwinds.

High capital costs

Development and operating costs for gold miners across the world have increased significantly over the past 10 years, driven especially high in the last few years by high interest rates and inflation.

In Q2 2023 the gold miners’ global average all-in sustaining cost (AISC), including labor, energy costs, machinery purchases and infrastructure prices, continued to climb, rising to US$1,315/oz, an increase of 6% y/y.

And rising interest rates and inflation also increases the cost to raise and borrow capital.

These costs inevitably tighten profit margins for gold miners.

However, even all-in sustaining costs at US$1,315/oz should easily be offset with gold price edging closer to US$2,200.

Misallocation of capital

Despite high profits, there is concern over what will be done with those profits.

When the gold price peaked in 2011, the gold mining sector went on a buying spree:

• capital expenditure in the sector increased significantly
• a series of expensive acquisitions, 348 deals worth more than $30.5 billion by 2019, for example:
  – Barrick Gold bought Equinox Minerals for US$7.3 billion
  – Kinross Gold bought Red Back Mining for $7.1 billion
  – Newmont bought Fronteer Gold for $2.3 billion

And then gold prices dropped sharply, from 2012-2019, meaning low returns and high debt, forcing the industry to dramatically cut costs.

Passive investment and Central Banks

Significant investment value in the gold mining industry is increasingly done through “passive” investment, such as ETFs.

In 2010, the aggregate market capitalization of gold mining equities was approximately US$300 billion. By the end of 2022, this market cap had fallen to US$260 billion — and, instead, gold-backed ETFs had accumulated assets worth nearly US$180 billion.

New research suggests — and, please note, also considerable debate — that passive investing dulls the market, especially for junior companies whose stocks are less able to reflect fundamentals due to the passive investment flows.

Compounding this concern over the type of investment in the sector is that the main driving force behind the recent surge in gold prices are central banks.

But central banks don’t need to invest in the gold mining companies themselves, they just want the gold.

Cash vs production shortfalls

There has been a recent series of press releases, especially from some of the bigger gold miners, that announced production shortfalls.

“Gold prices can only help so much, if you can’t produce the gold in the first place”

— Roxanna Islam, associate director of research at VettaFi, told Reuters

For example,

• Barrick Gold missed their production targets for 2023 
• Newmont Corp missed profit estimates for Q3 2023 
• Fanco-Nevada has cut guidance on it’s Cobre Panama mine
• Royal Gold sales volume was below the low end of their guidance in 2023

There are a variety of reasons behind these shortfalls, from labor strikes to overly aggressive targets, and, despite the subsequent fall in stock prices, many of these companies financials show significant free cash flow.

“A big part of our commitment is to deliver $100 million of free cash flow by bringing Newmont and Newcrest together…there is a reduction in headcount in order to achieve those synergies”

— Tom Palmer, Newmont CEO, told Reuters

The question is: what will this cash be used for?

The reserve life of the world’s top 10 gold miners has reportedly declined 33% in the last 10 years — which obviously means tight supply, increasingly in regions with high jurisdictional risks — but with timeframes of 10-20 years to develop a mine after a deposit has been found, risks tying up significant capital in volatile exploration and development.

For a sector that has a market cap approximately the size of Home Depot and concerns over the long-term price of gold, this is a risk. Anecdotal observations from Sprott suggests that “a consistent metal price range of $2,500 to $3,000 would be necessary to sustain the current annual mine production of 3,500 metric tonnes.”

Conclusion

Historically, it is not uncommon to see an early disconnect between the price of gold and gold miners, and the relatively small size of the gold mining sector means any small shift can make a significant impact. And some investors are starting to take an interest:

• Elliot Management has set up a US$1 billion fund to invest in mining, with a focus on lithium, nickel, copper, etc — as well as gold
• investor Stanley Druckenmiller has sold his tech stocks while putting funds into gold mining companies (and AI shares)

We believe the fundamentals are strong in driving up the price of gold and that high interest rates are putting a blanket over an even more dramatic breakout.

According to John Hathaway, senior portfolio manager, Sprott Asset Management, every Fed pivot has been followed by outsized gains in gold mining equities:

• period 5/00-1/08: 400%
• period 1/16-8/16: 238%
• period 3/20-7/20: 208%

However, we are less certain — and believe markets are increasingly uncertain — that the Fed will be lowering rates soon, as CPI remains stubbornly high.

So, as gold tries to break out of it’s inverse correlation with interest rates and the dollar, suggesting trust in the economy is low, the mining industry faces it’s own crucial test of trust.

Are investors confident in the mining companies’ prudent use of their newfound profits? And, more importantly, do investors trust the price of gold will continue to rise — and stay high.