Description

Long GDX:

While we have historically refrained from pitching macro or thematic investments on VIC, we view the current set up for gold miners as incredibly attractive and recommend buying a basket of miners via the GDX.  We are bullish on both the price of gold and the miners.  Given the significant lag relative to gold, we feel the miners are primed for a period of out-performance.   We believe this will be driven by continued strength in gold prices and a more favorable cost environment for the miners vs. the last 2 years.  Any fund flows out of mega cap tech into other parts of the market would also be a significant tailwind given the entire market cap of the GDX is ~$320bln, vs $11.8T for MSFT/AMZN/GOOG/NVDA/AAPL. 

For target prices, we consider GDX’s prior peaks in 2020 and 2022 in the low $40’s (up 30%+) as an easily achievable base case target.  We note that GLD itself was at least 10% lower then, suggesting a “parity” target for GDX of $45 (up 42%). But history shows that miners can dramatically overshoot targets after periods of lagging.  If we are right about a) continued GLD strength, b) continued alleviation of post-covid cost pressures on miners, and c) a flow of funds out of the Mag7/FANG complex, then conditions might be right for a sizable overshoot by GDX.  

Background:

Since the beginning of 2022 the GDX has lagged gold by ~19%.  Given gold miners should have a positive beta to gold prices given their operating leverage this is a very disappointing outcome.  We believe this is driven by a combination of negative earnings revisions caused by higher than expected costs and fund flows.  As the charts below show, margins have declined in a rising gold price environment, while costs have come in above guidance. This has been compounded by investor focus on other market segments (FANG, AI ect).  For many of the miners consensus EPS expectations have been consistently revised lower over the last 2 years, while also seeing valuation multiples compress.  This is especially true among the larger bellwether companies in the sector such as NEM, GOLD and FNV. 

While the miners have been disappointing, gold has been setting new nominal highs. This is despite the Fed raising interest rate over 5% and shrinking its balance sheet over the past 2 years.  This is historically unusual as gold prices tend to be negatively correlated with real rates.  Speculators also seem to have been net sellers of gold, as the amount of gold held in ETFs has been declining.  Central banks have more than offset this, significantly increasing their purchases since the start of the Russia/Ukraine war. 

Real rates (Inverted) vs Gold:

Gold’s Outlook:

We believe gold prices should continue to grind higher driven by several factors.

1: Rates are expected to move lower.  While the market could be wrong around the timing of a rate cut this year, the direction of Fed funds rates is lower over the next year.  Historically this has resulted in both gold and the GDX rallying. 

 2: The US dollar is historically expensive relative to other currencies and likely to decline in a rate cutting environment. At the very minimum it is unlikely going to be the headwind to gold prices that it has been over the past 2 years.