With Treasury yields elevated and market observers predicting more rate hikes courtesy of the Federal Reserve and other central banks, the current environment appears inhospitable to gold.
Throw in the ripple effects of the collapses of crypto banks and related lenders, and there’s a risk-off tenor to global financial markets at the moment — one that could be benefit the U.S. dollar while pinching dollar-denominated commodities in the process.
Put it all together, and it’s reasonable that many investors may be shying away from gold miners and exchange traded funds such as the VanEck Gold Miners ETF (GDX) and the VanEck Junior Gold Miners ETF (GDXJ). Indeed, the stocks held by these ETFs are correlated to spot gold prices, and shares of those firms have a tendency to overshoot price action in either direction.
That’s one reason why GDX, which is the largest ETF in this category, is lower on a year-to-date basis while the physically backed VanEck Merk Gold Trust (OUNZ) has been modestly higher since the start of 2023. Unattractive as that scenario may be, it’s not permanent, and it could belie valuation opportunity with gold miners. That is to say, gold mining stocks, including some residing in GDX and GDXJ, trade at depressed levels relative to free cash flow.
“Gold miners have rarely, if ever, traded below five times (5x) price[1]to-cash flow—particularly within the last 15 years,” according to VanEck research. “Historically, gold miners’ shares have actually rallied hard off such low valuations.”
Another plus for investors considering GDX and GDXJ is transformation in the gold mining space. Gone are the days of profligate spending and costly acquisitions simply in the name of gaining access to more reserves. In recent years, the industry turned its focus to balance sheet temerity, including reducing liabilities. Those efforts could pay off for long-term investors.
“A persistent focus on debt reduction and free cash flow generation has fundamentally transformed how these companies look on both an absolute and relative valuation perspective,” added VanEck.
Capital discipline is all the more important today because production is declining and costs are elevated, though tolerable, for producers. Focusing on financial discretion allows smart miners to not only strengthen balance sheets but also prioritize environmental, social, and governance (ESG) goals, which are increasingly points of emphasis in the industry.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.