|Shares Out. (in M):||396||P/E||20||17|
|Market Cap (in $M):||2,823||P/FCF||32||15|
|Net Debt (in $M):||-42||EBIT||0||0|
|TEV (in $M):||2,780||TEV/EBIT||0||0|
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Alamos Gold (AGI) offers investors: (1) a rising gold production outlook (+67% by 2027), (2) a declining cost profile (-34% AISC by 2025), (3) a management team that has been together for 18 years, has a history of enviable capital allocation, and has outperformed the gold price and its peers, and (4) the potential for a buyout by a senior producer; after 3 recent deals involving Canadian gold miners, AGI’s mines are now the most attractive independent assets of size in Canada, a low-risk jurisdiction sought after by global producers with exposure to high-risk jurisdiction.
Since gold miners offer leverage (both ways) to the gold price, I’ll first answer the question “Why gold, why now?” and then answer “Why Alamos?”
Why gold, why now?
Since October 2021, when Google searches for the word “stagflation” broke out to a new recent high, the price of crude oil is up 47% while gold is up 4%. Directionally, this is as it should be as crude historically has delivered the best average real return during stagflationary periods. However, gold - the second best performer - has historically generated 39% of crude’s average return, and since October it has delivered just 9% of crude’s return. Gold may be due for a catch up.
Source: In Gold We Trust
Another reason to consider gold is due to where we are in the commodities to equities cycle.
Source: Crescat Capital
There’s also the matter of the Fourth Turning that we’re in, which runs through about 2030. The authors of the 1997 book have already been proven right on a couple of predictions: a financial crisis followed by a period of calm and then a resuming of the unraveling through events such as “the spread of a new communicable disease” and a war. A half-fulfilled prediction of their was “Gold and oil prices soar.” We’ve seen the latter, but the former has been more muted. The last Fourth Turning occurred during the 1930s.
The following chart shows the performance of the DJIA (red line), Barron’s Gold Mining Index or BGMI (blue line) and Currency in Circulation or CinC data (green line) – all indexed to 1 in January 1920. In the 1930s, the BGMI consisted of just Homestake Mining and Alaska Juneau Gold, although the index has since expanded. Note that the BGMI preserved capital during the crash of 1929 and subsequent stock market decline – and, starting in 1932, it went on to deliver strong absolute returns.
Source: Barron’s & Goeff
Investment demand for gold could increase as we progress further into the turmoil of the Fourth Turning. On the supply side, the gold story is similar to the oil story: underinvestment in capex. The gold mining industry was plagued by terrible capital allocation during the peak of the last gold bull market (2011-2012), when companies paid significant premiums for acquisitions and went ahead with projects assuming perpetually high gold prices. This led to large write-downs in subsequent years.
Source: Crescat Capital
Most of the management teams at the worst offenders were replaced. Over the past few years, gold miners have shied away from capex, and have focused on FCF generation and returning capital to shareholders. There is a general reluctance to pay significant premiums for acquisitions and project IRRs are calculated using conservative $1,200-1,500/oz gold price assumptions (spot price: $1,825). As the following chart shows, capex is down substantially from the peak.
Source: Crescat Capital
Due to this underinvestment, there have been no new major gold discoveries during the last 4 years. At the 20 largest gold producers, production from proven and probable reserves is projected to remain flat out to 2025, and then go into long-term decline, getting cut in half by 2033.
Gold bugs often try to predict the catalysts that will spark a rise in the price of gold. I can’t remember any of them getting it right. If a catalyst can be identified, it’s probably late to buy gold, as financial markets are anticipatory. For example, gold started sniffing something in late 2018 and went on an 18-month run with no visible catalyst. Then Covid hit and by the time the Fed’s massive money printing program was unleashed, the smart money was selling to the dumb money piling in near the top, creating the mid-2020 peak. Another peak occurred earlier this year catalyzed by the outbreak of war in Ukraine.
However, the temperature of the gold market turned cold rather quickly as Fed rate hikes are seen as negative for gold, and the USD has been quite strong. The Gold Miners Bullish Percent Index ($BPGDM) has fallen to 20 - readings below 30 are considered oversold - and managed money net long gold futures contracts have plunged to their lowest level this year. Since gold is an insurance policy, you want to buy insurance when it's cheap.
The chart below is a 15-year composite showing gold’s seasonality. We’re now near the June seasonal low and over the short-term are set up for a run that, based on history, should last through Feb ‘23.
From a longer-term technical perspective, gold is showing a potentially very strong set up. The double top in mid-2020 and early-2022 potentially formed a cup. The weakness we’re experiencing now may be forming a handle. If this is a cup-and-handle formation, a very strong move higher could follow.
Why Alamos? – Part I
The quick answer is, Alamos is the gold miner that I believe has the greatest odds of being acquired next. With everyone’s attention on crypto, SPACs NFTs and cash burning SaaS companies that are supposedly eating the world (most of which are likely this cycle’s dot coms), Canadian gold mining assets have been quietly getting acquired by senior producers looking to replace their depleting reserves and increase their exposure to Canada, one of the best mining jurisdictions, in order to diversify away from high-risk jurisdictions.
The Canadian consolidation wave started with the MoE between Agnico Eagle and Kirkland Lake (KL) announced in Dec 2021, creating the largest Canadian producer by far. Then Australia-based Newcrest (with exposure to Papau New Guinea) acquired Canada’s Pretium Resources, followed Kinross Gold (with exposure to Chile, Mauritania and Ghana) buying Great Bear Resources (a Canadian exploration company), and South Africa-based Gold Fields (with exposure to Ghana, Peru and Chile) acquiring Canada’s Yamana Gold.
As the following chart shows, with Newmont being the world’s largest producer, Alamos is now the largest and highest quality remaining intermediate producer in Canada that could be acquired. The next largest – New Gold – is of far lower quality and has struggled to meet expectations for years. Alamos is (1) large enough to move the needle for a senior miner, and (2) it has a rising production outlook with 465,000 oz of production this year growing to >700,000 oz by 2027 if AGI remains independent, whereas a buyer with a larger balance sheet could accelerate new mine development and get AGI to >700,000 oz by 2025. Newmont produces just over 6 mn oz of gold annually, and #4 AngloGold Ashanti produces 2.7mn oz. The type of production growth AGI could generate as part of a senior producer would move the needle on the flat production outlook of any senior.
Source: AEM presentation
Most of the senior miners large enough to acquire Alamos are shown on the following chart from the AEM-KL merger presentation. The x-axis shows the NAV-weighted exposure to North America, Australia and Northern Europe (i.e., low risk jurisdictions).
Newmont, which is in the S&P 500 and based in Colorado, has solid exposure to the U.S. and Canada, but risker exposure to Suriname, Dominican Republic, Ghana, Peru and Argentina. Newmont was rumored to have been interested in Kirkland Lake.
Australia-based Newcrest’s position on the chart is pre-Pretium, which lowered its jurisdictional risk profile. Excluded from the chart is AngloGold Ashanti which would land at the 20% mark on the x-axis. It has the worst footprint of any global producer with 57% of its production in Africa (DRC, Ghana, Tanzania and Guinea), and its Americas exposure is in Argentina and Brazil.
Agnico Eagle’s highly respected management created an enviable footprint via the KL merger which should protect shareholders if and when jurisdictional risk becomes a reality. Since the KL merger was all stock, AEM does have the balance sheet to acquire AGI if it wanted to further dominate Canadian gold production, although IMO AGI should insist on AEM shares in such a deal.
Source: AEM presentation
The worst case outcome of jurisdictional risk was experienced by Alamos itself. It had mining assets in Turkey, which the government essentially expropriated by not granting a routine renewal of its mining licenses and forestry permit, well into the construction of the mine, despite Alamos having met all of the legal and regulatory requirements for renewal. AGI wrote off all of its assets in Turkey and has filed a $1.2 billion investment treaty claim against the Republic of Turkey. AGI’s CEO stated the following in a press release on 4/20/21:
“Alamos began investing in Turkey in 2010, warmly welcomed by the Turkish government through its foreign investment office. After 10 years of effort and over $250 million invested by the Company we have been shut down for over 18 months in a manner without precedent in Turkey, despite having received all the permits required to build and operate a mine. The Company has worked in Turkey to the highest standard of conduct with respect to social and environmental best practices. Despite this effort, the Turkish government has given us no indication that relief is in sight, nor will they engage with us in an effort to renew the outstanding licenses.” – John McCluskey.
No mining CEO wants to issue such a press release. But if you own mines in high risk jurisdictions, all you can do is dilute down your exposure through acquisitions in low risk jurisdictions. AGI’s impairment charge amounted to a not-great-but-not-terrible 9% of its market cap. Today, 70% of its production is in Canada, and 30% is in Mexico. Once the Lynn Lake mine in Canada starts producing (discussed later), Mexico will fall to 17%. And the Mexican operation has the shorted mine life of any of AGI’s assets, at 6 years. While AGI has a good track record of extending projected mine lives, Mexico will be the first of its operations to shut down, leaving AGI as a 100% Canadian producer.
Why Alamos? – Part II
You’ve already read about AGI’s only blemish: Turkey. The rest of the AGI story can be summarized in two words: high quality. Unlike other miners which had their management teams replaced for poor capital allocation, AGI’s management has been together for 18 years and has produced a very good capital allocation track record. They’ve made acquisitions when gold prices were depressed and substantially increased the value of those assets.