On Wednesday, Dec. 14, for just the second time in the past decade, the Federal Reserve decided to boost its federal funds target rate by 25 basis points to a range of 0.5%-0.75%. The Fed's impetus for lifting interest rates was steadily declining unemployment figures on the heels of recently strong job reports, and stronger-than-expected U.S. GDP growth.
The opportunity cost argument is losing its luster
Some industries lauded the move, with financials, in particular, mostly higher. Financial institutions that lend money and earn interest-based income can make even more money when those loans have variable rates and interest rates rise.
However, not all industries were happy to see interest rates go up by 25 basis points. For instance, physical gold and silver took a hit, which sent many gold and silver stocks dropping by 5% or more on Wednesday.
For years, opportunity cost, of the act of passing up a near-guaranteed return in favor of an asset which has the potential to deliver a greater return, has worked in gold's and silver's favor (and it still arguably does). The yields on Treasury bonds, bank CDs, and savings accounts are still quite low and not necessarily outpacing the national rate of inflation.
If the yield on an interest-bearing asset is less than the national inflation rate, the investor loses real money, even if they're making a nominal gain on the interest. In many cases we're still seeing interest-bearing assets with negative real money yields, or extremely low real money yields. This works in favor of physical gold and silver, which have no yield and rely on low opportunity costs to drive investors into precious metals.
But, following Wednesday's interest rate hike, and the likelihood that future rate hikes could be in the cards based on the U.S. economy's strong growth, as well as the sell-off in bonds (and subsequent spike in yields), the argument that low opportunity is the best reason to buy gold and silver stocks is probably not the primary reason to consider owning precious-metal miners anymore. Instead, the clear reason to consider buying gold and silver stocks is purely fundamental.
It's fundamental, my dear investor
Most mining companies have reduced their expenses, lowered debt, and increased their focus on higher ore grade mines, leading to sustainable profits and positive free cash flow even at $1,140 an ounce on gold. From a fundamental perspective, precious-metal miners look more attractive than they have in years.
Reducing capital expenditures (capex) and/or debt has been a key reason some gold and silver miners have been looking more fundamentally attractive.
For instance, silver miner Coeur Mining (NYSE:CDE) repaid a $99 million term loan in July, eliminating nearly 20% of its outstanding debt. Even though Coeur has been boosting its capital expenditures modestly to transition its operations from surface and underground operations to an entirely underground operation, the added flexibility of having less debt coupled with lower interest expenses should work as a win-win for a silver miner that was the cheapest based on future cash flow per share in October. Plus, once the transition to underground mining is complete, Coeur Mining's capex would be expected to fall considerably on an annual basis.
For Barrick Gold (NYSE:GOLD), it's been a mixture of reduced capex and debt repayment that's fueled its attractive valuation. When fiscal 2014 came to a close, Barrick Gold had $13.1 billion in debt. After repaying $3.1 billion last year, the company is on track to chop off another $2 billion in debt in 2016, leaving it with approximately $8 billion. As with Coeur Mining, less debt means more financial flexibility and less in interest expenses. Plus, ridding itself of non-core assets boosts the company's focus on its top-yielding projects. To boot, Barrick's full-year capex for 2016 is now $1.25 billion at the midpoint, down $250 million from the midpoint of guidance at the beginning of the year , and a better than 75% drop-off from the $6 billion the company expected to shell out in capex for fiscal 2013 when it released its 2012 annual report. Prudent spending and debt reduction has made Barrick a fundamentally attractive gold stock.
For other mining companies, their attractiveness lies in their opportunity to expand their production meaningfully, and at a relatively low cost.
Yamana Gold (NYSE:AUY) is a poster child for rapid production expansion. While most gold miners were pairing back on capex between 2011 and 2015, Yamana was busy working out deals and looking for ways to organically increase its production. It acquired the gold and copper-producing Riacho dos Macahdos mine from Carpathian Gold for less than $50 million and may wind up nearly doubling production to 100,000 ounces of gold annually in less than two years. It's also organically expanding production at C1 Santa Luz, Cerro Moro, and the Suruca development at its Chapada mine. C1 Santa Luz is the prize of these expansions, with an average of 114,000 ounces of annual production expected over the first seven years. C1 Santa Luz and Cerro Moro are expected to commence commercial production in 2018, with Suruca right behind in 2019.
For Kinross Gold (NYSE:KGC) it's all about one mine: Tasiast. After years of waiting to expand its flagship Mauritanian mine, Kinross allocated $300 million in capital costs and $428 million for stripping to move forward with phase 1 of its production expansion. This seemingly costly maneuver could nearly halve its cash costs, boost its throughput capacity by 50% per day to 12,000 tons per day, and allow the company to produce an average of 409,000 ounces of gold between 2018 and 2027. Should Kinross choose to also move forward with phase 2, its throughput capacity could soar to 30,000 tons/day, and its all-in sustaining costs could drop below $700 per ounce.
In many instances, investors are going to find gold and silver stocks trading at a single-digit multiple of future cash flow per share with healthy per-ounce margins relative to the current spot prices for physical gold and silver. While opportunity cost still favors investment in precious metals, it's the improving fundamentals of gold and silver stocks that makes them worth a closer look.