Since gold topped out in 2011, the precious metals mining sector has been where investor capital goes to die.
Mining stocks have performed miserably over the past seven years, missing out completely on the central bank-created liquidity-fest that has raised nearly every other equity sector to record highs.
But the long winter of abuse is over, claims highly-respected mining analyst John Hathaway, co-manager of the Toqueville Gold Fund. To John's veteran eye, the conditions in this beleaguered industry have improved substantially. Mining supply is tightening while demand is rising, and the surviving companies have achieved positive cash flows at today's depressed prices.
Claiming that we are now past "peak gold", Hathaway expects gold prices to move higher vigorously, propelling the shares of mining companies multiples higher from where they are today:
The industry hasn’t been able to issue equity to any substantial degree for five or six years. And, so they’ve gone more and more to streaming royalties, that sort of thing. But the industry is capital constrained and they always seem to be able to get capital, but what we see is a shrinking industry, shrinking gold production on a global basis and a wave of mergers and acquisitions. We’ve seen quite a few recently, the combination of Barrick and Randgold would be the first. We recently saw Pan American Silver take over Tahoe, and that wasn't as big a deal, but certainly it was significant. And then there have a been a lot of little private deals you don’t hear about.
The industry is running out of reserves. The reserve to production ratio is the lowest it has been in 30 years. We’ve seen peak gold. And we expect that the supply of newly-mined gold will continue to decline for several more years. If you were to say to me, “Gold is going to trade tomorrow at $2,000,” I wouldn’t change that forecast, because it takes so many years to build a gold mine. It’s a lot different than shale oil, where you get small increments from a lot of different producers. Not to mention host countries — even Mexico recently, which used to be thought of as a good mining province, good mining country — are becoming tougher and tougher on the capital they want to enter their countries and build mines. So, the hurdle rate, the investment return is going higher and higher.
So, to try to tie that together, you have a very bullish supply and demand outlook. Declining production, declining supply, and steadily rising demand — simply coming from a rising middle class in parts of the world that most of us don’t even go to. I'm not talking about the kinds of things that happen in the thought process of western capital markets. We’re just talking about more babies, more families, more marriages, growing population. Where do you, where do you, how, if you live in India or Sri Lanka or Indonesia or Egypt and you want to salt something away, you don’t do it in local currency. You do it probably in some form of physical gold. So that's in the DNA of the emerging markets of the world. And, that’s not going to change. So you definitely have very bullish supply and demand situation.
And the financial condition of the mining companies is quite decent. I would say many of them are generating cashflow, even free cashflow at these low levels. What they can’t do, and which is probably a very bullish thing for supply and demand, is issue a lot of equity, because nobody, nobody will buy it or it’s too expensive. So, I think we have a window here where the supply and demand imbalance coming from the mining industry itself is exceptionally bullish. And, believe me, I think when this cycle advances, that's going to be a one of the major reasons why people jump back in.
Click the play button below to listen to Chris' interview with John Hathaway (45m:41s).