Gold Miners Shine: Record Q2 Results Signal Strong Momentum in Precious Metals Sector

• Gold stocks have outperformed the gold commodity price since Q2 reporting, with large producers like Agnico Eagle posting record free cash flow.
• Operating cash flow for major gold producers increased by an average of 65% year-over-year in Q2 2024.
• While large-cap gold stocks have performed well, the rally is to be extended to junior producers and developers.
• There are signs of increased interest in the gold sector, including off-season financings for junior companies in August.
• Upcoming industry conferences in September could catalyze news flow and potential M&A activity in the gold sector.

The Golden Opportunity: Gold Stocks in the Current Market

The gold mining sector has shown remarkable resilience and growth in recent months, outpacing the performance of gold as a commodity. This divergence presents a potentially lucrative opportunity for investors seeking exposure to the precious metals market. As global economic uncertainties persist and inflationary pressures mount, gold stocks are increasingly catching the eye of both specialist resource investors and generalist fund managers. Derek MacPherson and Sam Pelaez, executives at Olive Resource Capital, examine the current state of the gold mining industry, recent performance metrics, and the potential for further upside in gold equities.

Strong Q2 Performance Signals Industry Health

The second quarter of 2024 proved to be a watershed moment for many gold mining companies. Industry leaders such as Barrick Gold, Newmont Corporation, and Agnico Eagle Mines reported impressive financial results, with Agnico Eagle notably achieving record free cash flow. This surge in profitability wasn't isolated to a few top performers; across the board, major gold producers demonstrated significant year-over-year improvements in their operating cash flows.

According to Samuel Pelaez, President, CEO and CIO of Olive Resource Capital:

"If you average the increase over these four companies [Barrick, Newmont, Agnico Eagle, and AngloGold Ashanti], it's about 65%. So I call that very material, 65%."

The average increase in operating cash flow for a select group of large gold producers was approximately 65% compared to the same quarter in 2023. This remarkable growth in cash generation is a clear indicator of the sector's improving fundamentals and operational efficiency.

The substantial increase in cash flows can be attributed to several factors:

• Higher gold prices: The average gold price in Q2 2024 was significantly higher than in the previous year, boosting top-line revenues.
• Operational improvements: Many gold miners have focused on cost reduction and efficiency enhancements, leading to better margins.
• Production increases: Some companies have successfully ramped up production, contributing to higher overall output and sales volumes.

Relative Performance: Gold Stocks vs. Gold Price

One of the most noteworthy trends observed in recent months is the outperformance of gold equities relative to the price of gold itself. This divergence is particularly significant given the historical tendency of gold stocks to act as a leveraged play on the gold price.

Pelaez noted:

"Since our last episode, which was roughly a month ago, the gold price has moved just over 5%. The basket of stocks we're looking at, they've increased in value about 15%. That's a 3:1 move."

This 3:1 outperformance ratio is a positive sign for investors in gold equities, as it suggests that the market is beginning to recognize and price in the improved fundamentals of gold mining companies.

However, it's important to note that this outperformance may still have room to run. Pelaez elaborated on this point:

"Historically, what we see when there's these big moves, gold stocks should at least double the performance of gold over that period. There's still about a 30% left to comply with that expectation from the past."

The Generalist Investor Perspective

As the performance of gold mining stocks continues to improve, there's growing potential for increased interest from generalist investors. These investors, who may not typically focus on the resource sector, often look for two key factors when considering an investment: profitability and growth.

The recent surge in operating cash flows addresses both of these criteria. With many gold producers now generating record cash flows and demonstrating strong year-over-year growth, they are becoming increasingly attractive to a broader investor base. This expanding interest could lead to multiple expansion for gold stocks, as investors become willing to pay higher premiums for companies showing robust growth profiles.

Pelaez explained the generalist perspective:

"The generalists look for two things in particular: one is profitability, the second one is growth. Growth is what leads to the multiple expansion." He added, "Typically, what you'd hear people in New York who are generalist is they'll pay up to 2x the growth on multiple."

The recent surge in operating cash flows addresses both of these criteria. With many gold producers now generating record cash flows and demonstrating strong year-over-year growth, they are becoming increasingly attractive to a broader investor base. This expanding interest could lead to multiple expansion for gold stocks, as investors become willing to pay higher premiums for companies showing robust growth profiles.

Seasonal Factors & Upcoming Catalysts

Investors should be aware of the seasonal patterns that often affect the gold market. Typically, August is considered a seasonally strong period for gold, while September tends to be weaker. However, the fact that gold stocks have performed well heading into a traditionally weak season could be seen as a positive sign of underlying strength in the sector.

Several upcoming events could serve as potential catalysts for the gold mining sector:

• September Fed Meeting: The Federal Reserve's September meeting, which often coincides with the Denver Gold Forum, can create volatility in the US dollar and, by extension, in commodity prices including gold.
• Industry Conferences: The Beaver Creek Precious Metals Summit and the Denver Gold Forum, both held in September, are major events for the industry. These conferences often serve as platforms for companies to make significant announcements, potentially including merger and acquisition news.
• Summer Drilling Results: Many junior exploration companies will be releasing results from their summer drilling programs, which could drive interest in specific stocks or regions.
• Potential for New Financings: As junior companies exhaust their summer budgets, there may be an increase in capital raising activities, which could provide opportunities for investors to participate in new issues.

The Trickling Down Effect: From Majors to Juniors

While the performance of large-cap gold producers has been strong, the rally has not yet fully extended to the junior and development-stage companies. This lag is not unusual in the early stages of a gold bull market. Historically, the initial moves tend to favor larger, more liquid producers before capital and interest flow down to smaller companies. Pelaez observed:

"We particularly like the small producers. We've actually seen pretty good performance already in that space."

Companies like Lundin Gold, which fall into the small to mid-tier producer category, have seen solid share price appreciation.

However, he also noted that this performance:

"[The performance] has not translated yet into the developers. Typically, you have the waterfall where you have the majors performing first, then you get the push from the intermediates. Then you get to the very small producers, then you get to the developers."

Furthermore, there have been some notable M&A events in the resource sector, such as the recent takeover of Osisko Mining. While this was primarily a copper-focused transaction, it demonstrates that there is appetite for acquisitions in the mining space. Such deals often lead to a recycling of capital, with investors reinvesting proceeds into other junior mining stocks, potentially including gold-focused companies.

The Importance of Funding in the Junior Space

For junior explorers and developers, access to capital is crucial. The past 18 months have been challenging in terms of raising funds, but there are indications that this situation is improving. Macpherson points out that there have been some unexpected financings occurring in August, which is typically a quiet period for such activities.

The ability to raise capital is often a catalyst in itself for junior mining stocks. Companies that can secure funding are better positioned to advance their projects and generate the news flow that drives share price performance. As the sector gains momentum, investors should pay close attention to which companies are successfully raising capital, as these may be better positioned to outperform.

Potential for M&A Activity

As larger producers generate significant cash flows and seek to replenish their project pipelines, there's potential for increased merger and acquisition activity in the sector. The recent takeover of Osisko Mining, while not a gold-focused deal, demonstrates that there's appetite for quality assets in the mining space.

Investors should be alert to the possibility of takeover premiums emerging for junior companies with attractive projects or strategic land positions. Such M&A activity can create opportunities for significant returns, especially for those invested in junior explorers or developers that become acquisition targets.

Challenges & Risks

While the outlook for gold stocks appears positive, investors should be aware of potential risks:

• Gold Price Volatility: The performance of gold equities is still closely tied to the price of gold, which can be volatile and influenced by various macroeconomic factors.
• Operational Risks: Mining operations can face challenges such as geopolitical issues, technical difficulties, or resource depletion that can impact individual company performance.
• Market Sentiment: Despite improving fundamentals, the broader market sentiment towards gold can influence stock performance, particularly in the short term.
• Liquidity Concerns: Smaller cap stocks in the gold sector may have lower trading volumes, potentially making it difficult to enter or exit positions without impacting the share price.

The Investment Thesis for Gold

• Strong fundamentals: Major gold producers are generating record cash flows, with an average 65% year-over-year increase in Q2 2024.
• Relative value: Gold stocks have outperformed the gold price by a 3:1 ratio recently, but historical patterns suggest there may still be 30% upside potential.
• Expansion potential: As generalist investors recognize the growth and profitability in the sector, there's potential for multiple expansion in gold stocks.
• M&A opportunities: Increased cash flows for major producers may drive acquisition activity, potentially benefiting investors in junior companies.
• Diversification benefits: Gold stocks can offer portfolio diversification and a hedge against economic uncertainties and inflationary pressures.

The gold mining sector is demonstrating strong fundamentals, with major producers reporting significant increases in cash flows and operational efficiencies. While large-cap gold stocks have led the recent rally, there's potential for this performance to extend to smaller producers and developers. Upcoming industry events and the possibility of increased M&A activity could serve as catalysts for further growth in the sector. However, investors should approach gold stocks with a clear understanding of the associated risks and the cyclical nature of the mining industry. The current market conditions suggest that gold mining stocks may offer an attractive opportunity for investors seeking exposure to precious metals, with the potential for outperformance relative to the gold price itself.