Though precious metals have been the focus of various weekly comments in the past, predominantly by specialists within our precious metals team, I wanted to offer a somewhat different perspective, drawing attention to the opportunity that exists by investing in companies within the sector rather than in the physical metals themselves.
We last commented on market dynamics in the early part of 2023. While the trends identified in those weeklies were in their infancy the momentum through 2024 has accelerated. Significantly, this latest expansion in the price of physical gold and silver is occurring through a period where an historical inverse relationship between real interest rates and the gold price has broken down (see fig. 1) giving investors reason to believe we’re at a watershed moment for the sector.
Figure 1
The remarkable surge in the gold price can be attributed to various factors, predominantly increased central bank buying and an unstable geo-political environment. Notwithstanding, an anomaly in the market is occurring where physical gold on the Shanghai exchange is changing hands at a premium to the international spot price as unprecedented gold demand drives the market higher.
Fundamental factors are more to the fore from a silver perspective. A structural deficit in the silver market has developed since 2021 (fig. 2), meaning more silver is being used each year than is being unearthed, as industrial usage intensifies, with the ongoing energy transition a significant contributing factor. By way of an example, the metal is an integral component within the production of solar panels.
Figure 2
Source: Silverinstitute
The case for investing in companies within the precious metal mining sector is building momentum, not only from the allure of the underlying commodity standpoint. After recent years of underperformance versus the wider market (see fig. 3) and indeed relative to the underlying physical commodity, fundamentals within the sector are at attractive levels whilst the diversification element also needs to be taken into consideration.
Figure 3
Source: Chart created by Ravenscroft (data from FEfundinfo2024)
Precious metal shares currently trade at a discount to the broader market, whether looking from a price-to-earnings (P/E) or price-to-book (P/B) basis, however, companies have historically lagged from a profitability sense. Notwithstanding, after years of cost cutting and the recent surge in underlying prices, profitability metrics are improving.
The all-in sustaining costs to extract precious metals out of the ground varies widely across companies, although analysis by S&P Global Market Intelligence1 looking at the average across 11 major gold miners suggested the weighted average mean of companies’ costs was $1,345oz, resulting in profit margins of 30.2%. With spot hitting $2,400 per ounce and costs forecast to fall over 2024 it is anticipated margins will expand, particularly if there is a weakening of the US dollar and/or cutting of US real interest rates.
Guidance2 by Endeavour Silver Corp (NYSE: EXK) indicated the equivalent cost to extract an ounce of silver will range between $22 and $23 per ounce for 2024, while, at time of the writing, the value of an ounce of silver was in touching distance of $30.
From an ownership standpoint, precious metals would typically be included in portfolios as a form of insurance against geo-political turmoil, elevated inflationary conditions or concerns surrounding fiat currency debasement. ETF holdings would imply the sector is still largely under-owned, giving ample opportunity for the sector to re-rate from here.
One could argue current market conditions are still providing an appealing backdrop for the sector. None of the tailwinds that initially fuelled the current bull market have dissipated, indeed, if anything, the environment has become more supportive from a weakening US Dollar and lower real interest rates. Whereas, historically, equities trailed the moves higher in gold and silver prices, these moves have only just really begun.
From a Ravenscroft perspective, we have exposure across the group, including a dedicated precious metals offering, exposure to mining share vehicles within our advisory service, and indirect exposure through silver and gold mining shares within one of our preferred managers across our discretionary portfolios.
Sources:
