Why Gold Investments Make Sense Again: Higher Prices and Margin Expansion Make Gold Miners an Attractive Buy

• Gold prices have seen sustained momentum since late February/early March 2024, rebasing to the $2,000-$2,300 level with talk of potentially rising to $3,000. by year-end
• Buying is coming from China and central banks; gold is seen as a hard asset to own during uncertain "wartime" economic conditions
• Junior gold companies are seeing interest from investors looking for 5-10x returns before the expected margin expansion for larger producers flows through
• Historically gold equities provide capital gains rather than yield; the current setup could allow for margin expansion in the near-term
• Longer mine life gold projects (20+ years) and copper-gold porphyries are gaining favor to diversify risk across multiple cycles

Gold: An Attractive Investment in the Current Environment

Gold has emerged as a compelling investment opportunity in 2024 amid a shifting macroeconomic and geopolitical landscape. After years of lackluster performance despite loose monetary policies and currency debasement, the gold price has broken out to the upside in a meaningful way. A confluence of factors, including economic uncertainty, central bank buying, and a favorable setup for producers, is making gold an attractive asset for investors to consider adding to their portfolios.

Sustained Momentum and a Higher Base

The gold price has seen notable strength since late February and early March of this year, rebasing from the $2,000 to $2,300 per ounce level. This move was a major topic of discussion at the recent PDAC conference, with a growing conviction that gold has established a new floor at these higher prices. Talk has even turned to the potential for gold to make a run at $3,000 per ounce.

As Sam Lee, CEO of Northisle Copper and Gold, noted, "There's certainly talk around, what does a $3,000 price environment look like around this conference?"Investors are gaining confidence in the sustainability of these elevated gold prices. According to Lee, "There's much more conviction clearly in the sustainability of the price levels today, which is leading to significantly more risk on behavior."

This shift in sentiment is an important change from the more cautious tone in March and sets the stage for an interesting second quarter.

Drivers of Demand

A key driver of the surging gold price has been increasing demand from China and central banks around the world. Investors are gravitating towards hard assets like gold given the uncertain economic environment and geopolitical tensions. Lee framed it as "accumulating assets, hard assets during what I would consider a wartime scenario", characterized by countries aligning with allies and a general distrust between nations. This backdrop "bodes poorly for fiat currencies", which have underperformed even their historical averages recently. The appeal of gold as a safe haven is evident.

Potential for Margin Expansion

The outlook for gold mining companies is also constructive. While producers have faced cost inflation over the past few years without a commensurate rise in gold prices, and squeezing margins, the setup going forward is more favorable. Lee explained, "We're seeing costs increasing to the point of excessiveness and a catch-up trade with gold.

So what does that mean? Well, it means that the initial valuations get obviously impacted by contracting margins."However, if gold prices can sustain their recent gains while cost pressures moderate, the industry could enjoy margin expansion in the coming quarters. "I actually believe we're in that environment, because clearly we can see the gold price, where the revenue line is going to be for the next couple of quarters. And unless you're hedged, which very few of these companies are, they've learned their lessons from many mistakes in the past, you are going to see margin expansion," Lee added. This dynamic, combined with the currently depressed valuations for many larger miners, could make for an attractive entry point.

Junior Miners Gaining Traction

Interestingly, junior gold companies have been garnering attention from investors despite the lack of a strong move in the larger producers. Lee noted an "odd" inverse cascading effect, with investors looking to identify potential 5-10x returns in smaller companies before margin expansion takes hold in the big players. "The sort of certainly the first thing we're getting here in Zurich is that investors now want to find that five to ten bagger before you know these fundamental margin expansion motifs," he observed.

While juniors are inherently riskier and stock selection is critical, Lee sees a "pretty strong theme around the stock picking strategies that are kind of resonating within the discussions here." For investors with higher risk tolerance, allocating a portion of a portfolio to quality junior miners could provide significant upside potential.

Seeking Longer-Life Assets

A notable shift in the gold industry in recent years has been a focus on longer-life projects. Historically, gold equities were seen primarily as vehicles for capital gains rather than yield. With smaller mines that might have 8-10 year production spans, stated IRRs in the 30%+ range were less meaningful because they didn't account for the need to constantly redeploy capital. "You have to redeploy that capital in order to make that a 10, 15, 20-year mine life," Lee pointed out.

Now, companies are increasingly looking for projects with mine lives of 20 years or more to be sustainable through multiple cycles. Copper-gold porphyries with lifespans of 30-50+ years are gaining favor in particular. "I truly think that to be sustainable in the financial sense, gold companies have recognized that long-dated assets are the way to go and certainly porphyries allow you to have that ability to weather multiple cycles as opposed to having to live and die by these very short periods of investment opportunity," Lee said. This trend towards copper-gold projects also helps diversify risk for miners and investors.

The Investment Thesis for Gold

• Gold prices have broken out to the upside in 2024 and established a new base above $2,000/oz with potential for further gains
• Demand is strong and coming from China, central banks, and investors looking for hard assets in an uncertain "wartime" economic environment
• Gold producers could see margin expansion in the near term if elevated prices are sustained while cost inflation pressures ease
• Junior gold companies offer the potential for 5-10x returns for investors with higher risk tolerance
• Focus is shifting to longer-life gold projects of 20+ years, especially copper-gold porphyries, to diversify risk across cycles
• Consider adding gold exposure to your portfolio as a safe haven with upside potential in the current macro backdrop

Gold stands out as a compelling investment opportunity in the current environment. A combination of strong demand from key sources like China and central banks, a favorable setup for margin expansion at gold producers, and the potential for eye-catching returns in junior miners make a strong case for gaining some exposure to gold. Investors should do their due diligence and consider which segment of the market is most appropriate for their risk tolerance, but an allocation to gold could be a prudent way to navigate today's uncertain economic and geopolitical waters while capturing the upside.