Venture: Gold Exploration
Issue 37;
Time to Consider Gold Exploration
The smart crowd will tell you that the gold miners are risky businesses and that the royalty companies, which are lenders with the first claim on gold production, are much better businesses. That is true because having the first claim on production is a position of privilege that gets fed first, while the miner carries on producing until it’s their turn.
But what happens when the price of gold rises?
The high-quality, low-risk royalty companies, such as Franco Nevada (FNV), start to lag the market as we can see here. And worst still, they start to lag the gold mining sector (black) significantly.
The Best Stocks Can Lose in Bull Markets
That’s because the gold price is high enough to float all boats, and the gold miners are seeing their profitability increase, and so they outperform the royalty companies, whose margins are stable. As the gold price keeps on rising further, margins rise across the board, until one day, the miners are so profitable they simply match the performance of the gold price. Under those circumstances, to keep on growing profits, they must boost production.
If you extrapolate that, you get to a point where the exploration companies become the most desirable assets because they have negative margins that can only improve and the potential for vast production growth. That makes gold exploration stocks the most desirable business model during established gold bull markets, as these companies are the only ones capable of delivering positive surprises at high gold prices.
I was told that in the late 1970s, at the peak of the greatest gold bull market of all time, the gold miners traded at a premium to the value of their reserves. With the gold price above $2,500, it’s time to embrace gold exploration.
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