It's been a frustrating year for most of Wall Street, but it's been a humdinger of a year if you're invested in gold mining stocks.
Of the 26 gold miners with market valuations north of $300 million, 25 are up for the year, with 16 of those 25 having at least doubled in price. In fact, gold miners with at least a $300 million market valuation have an average return of a brisk 128% through the first half of 2016! Mind you, the stock market historically returns around 7% per year with dividend reinvestment.
Why gold, and gold miners, are soaring in 2016
"What's been driving gold higher?" you wonder? It's actually not one factor in particular, but rather a confluence of events that have created an almost utopian scenario for metals investors.
The most obvious credit (or blame) should go to Brexit, which creates quite the air of uncertainty throughout Europe and the global markets. While the possibility of Britain leaving the EU was always on the table, essentially no financial pundits projected voters would actually choose to leave. But, that's exactly what they did by a vote of 51.9% to 48.1%. With Brexit now a reality, Britain will need to rework trade deals in what could be a lengthy and opaque process. In short, gold has risen as a direct result of the unprecedented uncertainty created by Brexit.
Secondly, we've witnessed discernable weakness in the U.S. dollar, though that has abated in recent days with the British pound and euro taking a beating in light of Brexit. The dollar and gold tend to move in opposite directions of one another. The dollar usually moves in-step with the U.S. economy; thus a falling or stagnant dollar could imply weaker than expected U.S. economic growth.
But by far the biggest catalyst for gold has been persistently low interest rates. Global growth uncertainty and Brexit have created a situation which could see the central banks of developed countries further lowering interest rates, or at worst staying pat. Low lending rates reduce the opportunity cost of buying precious metals that don't pay dividends, which can boost demand for these metals and increase spot prices. With little relief on the way for income-seeking investors, gold is looking more and more like an intriguing opportunity.
The cheapest gold miner based on future cash flow per share
The bullish outlook for gold might lead you to believe that you could simply throw a dart and buy whatever miner your dart lands on. Unfortunately, I'm not a fan of blind guessing.
A much better measure of value that I prefer to use when examining gold miners is future cash flow per share. In simpler terms, this means looking at the upcoming year's (i.e., 2017) cash flow per share (CFPS) estimates from analysts and dividing a company's current share price into its future CFPS. The lower the figure, presumably the cheaper the company is valued. I gravitate toward the future CFPS measure because 1) the market is always forward-looking, and 2) most mining companies are carrying debt, thus strongly positive cash flow implies that a company is capable of servicing its debt and maintaining or expanding its mines.
With this in mind, I decided to examine the 20-largest gold miners by market valuation as of the end of June. Using Thomson Reuters' CFPS estimates as my source, the only criterion was that there had to be a 2017 CFPS estimate available. If not, the gold miner was not included. Running a screen of these 20 gold miners meant excluding AngoGold Ashanti, Gold Fields, Sibanye Gold, NovaGold Resources, Harmony Gold Mining, and McEwen Mining since no estimates were readily available.
Of the 14 remaining mid-cap and large-cap gold miners, here's how the price-to-future-CFPS data shaped up:
- Kinross Gold (NYSE:KGC): 5.4
- IAMGOLD: 6.2
- Yamana Gold: 7.1
- Newmont Mining (NYSE:NEM): 7.8
- New Gold: 8.3
- Barrick Gold: 9.5
- Goldcorp: 10
- B2Gold: 10.5
- Alamos Gold: 11.9
- Eldorado Gold: 14.1
- Agnico-Eagle Mines: 15.1
- Randgold Resources: 16.7
- Royal Gold (NASDAQ:RGLD): 17.3
- Franco-Nevada: 30.4
You'll note that some of this data probably comes as little shock. For instance, gold royalty stream company Royal Gold is the second most expensive gold stock based on price-to-future-CFPS. Since Royal Gold isn't a traditional mining company, its overhead costs tend to be much lower than those of traditional miners, and its margins tend to be more robust. When gold prices rise, Royal Gold is likely to feel the benefit more so than traditional mining companies. Thus, seeing Royal Gold valued so richly compared to other gold stocks with gold prices on a tear makes sense.
Newmont Mining's relatively inexpensive valuation on a price-to-future-CFPS basis also makes sense considering the strides it's made to reduce its capital expenditures. Following a handful of multi-billion dollar writedowns between 2011 and 2013 that held down its valuation, Newmont has managed to bring the midpoint of its all-in sustaining cost estimate down to $910 an ounce in 2016. Further, it's only been throwing capital at its most profitable and high-grade ore mines. After years of underperformance, Newmont could be ready to shine.
Surprise, Kinross Gold could be a steal
However, the real surprise of this data mine (pun intended) is that underperforming gold stock Kinross Gold could be the steal of the bunch.
Kinross has been dragged down for years by its (in hindsight) horrendously overpriced purchase of the Tasiast Mine in Mauritania. Kinross acquired the mine with its acquisition of Red Back Mining in 2010 for $7.1 billion, but it wound up writing down quite a bit on the value of the Tasiast Mine in the years to follow. In 2012, Kinross wrote down $2.49 billion in value on Tasiast, and in the following year it sliced off another $3.09 billion in a second write down.
But times are a-changing! In late May Kinross Gold announced that it was going to spend $300 million (plus another $428 million in stripping costs) to boost the milling capacity at Tasiast from 8,000 tons of ore per day to 12,000 tons of ore. The mill, which is expected to reach full capacity by the first quarter of 2018, will not only boost production by 87%, but it's expected to reduce production costs at the mine to approximately $535 an ounce from its current cost of nearly $1,000 an ounce. On an all-in sustaining basis we're talking about $760 per ounce. If the company chooses to go ahead with a second phase of expansion toward the end of the decade, it could get its AISC down to $665 an ounce by 2020. Although Kinross will be spending a bit more than initially expected in 2016, its results in 2017 and beyond should be considerably better than expected, especially with gold prices soaring.
Beyond splurging on Tasiast (finally!), Kinross has been aggressively cutting costs for years. Part of this cost-cutting plan has involved lowering its debt, which in turn lowers its interest expenses. Long-term debt in Q1 stood at $848.5 million, which is down substantially from the more than $1 billion it began fiscal 2015 with.
Valued at only 5.4 times its 2017 cash flow per share, Kinross Gold could be a name worth serious consideration for precious-metal investors.