LAWRIE WILLIAMS: Gold not performing but gold stocks still excellent growth prospect
Gold and silver prices have been caught in a coronavirus vaccine induced malaise. In our view the anticipation that the likely availability of several effective vaccines will bring a rapid end to the economic downturn that has resulted from moves to combat the pandemic spread is both premature and ill-judged. Despite the Pfizer vaccine already being utilised in the UK and being launched in the U.S. within the next few days, as well as other vaccines from Moderna and Astra Zeneca likely to be approved shortly, not to mention other locally-produced vaccines already being administered in China and Russia, the pandemic spread is still a long way from being conquered.
Indeed the infection spread is likely to get worse before it gets better with the Thanksgiving, Christmas, Hannukah and New Year celebrations and easing of restrictions likely to generate further infection spikes. Indeed it may well not be until the second half of 2021 before we see any impact of the vaccines on infection spread and any economic recovery begin. There is also the likelihood of an important proportion of the global populace refusing vaccination, partly due to the fear that rushed vaccine approvals may be short circuiting the usual safety checks and balances.
Logically the likelihood of the pandemic effects on the global economy continuing for longer than many, or even most, see as likely should enable the safe haven benefits of precious metals continue to boost prices. But markets frequently behave in a seemingly illogical manner so what are the alternatives for those who believe that precious metals should indeed benefit, but fail to generate the anticipated price advances, but rather mark time at, or around, current price levels? The answer may well be gold mining stocks – and here we’d recommend the major gold mining companies as perhaps offering the best revenue potential, but with the least risk attached.
Any kind of mining is effectively a high risk business with operating mines potentially subject to technological, and sometimes political, issues. The advantage of the major miners here is that they mostly have a broad range of operations, and if one mine suffers problems the impact on the overall company is somewhat limited. A smaller mining company with just one, or a few, producing mines could see earnings devastated by problems at just one of its operations.
Because of metal price weakness, gold mining stock prices may well be depressed too, yet the major miners are turning in huge profits at current gold price levels. Most produce their gold at all in sustaining costs (AISC) of around $1,000 an ounce, so even at $1,800 an ounce gold the margins are enormously positive. Given most of these companies are dividend payers, and the huge profit margins in turn likely to lead to enhanced profits, virtually all of these mining companies are able to increase their dividend payouts to shareholders, and thus beginning to generate respectable yields. In the current low interest rate environment this can be particularly significant for the investor. And that, I emphasise, is at current gold price levels. Should the gold price regain some of its lustre, then profit margins will be even further enhanced and share prices should benefit accordingly. Indeed the leverage tends to far exceed that of the rising metal price.
In a recent publication, London-based precious metals specialist analytical group, Metals Focus, points out that dividends, although they are rising, have been doing so at a lower rate than might have been expected due to the miners prioritising reducing debt utilising both cashflow and sale of non-core assets. However we note that in many cases the debt position is now far more manageable and likely to result in even further prioritisation of dividend outflows, which bodes well for the gold stock investor.
The dearth of big new deposits available for exploitation, together with a reluctance of the banking sector to finance multi-billion dollar new mine developments, means that major capital expenditures, that might lead to massive debt increases again, are mainly on hold. Mining company management seems to have dropped the ‘growth at any cost’ pattern of expenditure in favour of more attention to both operating cost control and shareholder support which suggests a sector reappraisal by the markets becomes increasingly likely. True the gold price has dropped below the average received in Q3 – estimated by Metals Focus at over $1,890 an ounce, but it has not fallen back that significantly and the gold miners are still raking in massive profits at current gold price levels.
Metals Focus thus sees the major gold mining stocks it follows as undervalued – and we concur. Despite the increased leverage and the dividends offered by the better gold mining stocksthey have underperformed gold bullion year to date, as represented by the HUI Index. Admittedly the underperformance is only marginal but in our view they should in reality outperform the metal price comfortably in what is still probably a gold bull market. They thus offer a great alternative to investment in gold bullion and in a rising market should show strong returns. And the dividends are, of course, an additional welcome bonus.