With the price of gold at an all-time high, we would like to highlight the investment opportunity we see in gold mining stocks.
Over the past five years, gold mining stocks have underperformed relative to the price of gold. The ARCA Gold Bugs Index has risen by 55% since 2019, compared to an 80% increase in the price of the physical metal. This underperformance is notable due to the significant challenges gold miners faced during the COVID-19 pandemic. Because you can’t “work from home” at a gold mine, social distancing, quarantining of workers and workforces, and government-imposed limits on movements across certain state lines resulted in inefficient operations and caused unit mining costs to increase substantially. These disruptions caused a substantial increase in mining costs, with the average cost to mine an ounce of gold rising from approximately $1,000 in early 2020 to around $1,400 today.
During the pandemic, while the price of gold increased from about $1,550 per ounce at the end of 2019 to $1,950 per ounce by mid-2022, the $400-per-ounce increase in revenue for miners was offset by a corresponding $400-per-ounce rise in mining costs. This squeezed profit margins, leading to market disappointment and underperformance of mining stocks.
However, since the start of this year, the price of gold has surged by $700 per ounce, while mining costs have remained stable. As a result, this entire price increase is flowing directly to the bottom lines of gold miners. To illustrate, at the start of the pandemic, gold was priced at $1,550 per ounce, with a mining cost of $1,000, yielding a $550 per ounce profit margin. Today, with gold priced at $2,750 per ounce and mining costs at $1,400, the profit margin has expanded to $1,350 per ounce—an increase of 150%. Yet, despite this margin expansion, gold mining stocks have only risen by 55%.
This significant margin improvement will likely be reflected in upcoming quarterly reports, where miners are expected to show strong free cash flow generation. As companies use this cash flow to pay down debt, repurchase shares, and eventually raise dividends, we believe the market will take notice, and gold mining stocks will once again shine.
