NEM - Why I'm So Bullish On Agnico Eagle Mines

2023-08-30 08:43:52 ET

Summary

• I'm re-entering the gold market due to mounting risks of Fed rate cuts and weak economic growth.
• Economic indicators like weak ISM indices and labor market decline support my thesis.
• Investing in gold miners like Agnico Eagle Mines offers potential as economic conditions worsen, while its strong operational performance and growth prospects make it appealing in a gold-price-driven market.

Introduction

I'm getting into gold again. Yesterday, I wrote an article with the very bullish article title Why I Believe That Newmont Could Triple . The reason I'm getting into gold again is my belief that economic risks could be rising to the extent that the Fed may be forced to cut rates.

Don't get me wrong, I've been in the higher-for-longer camp for a while, and I have made the case for prolonged sticky inflation when inflation wasn't even elevated.

However, my thesis is a long-term thesis. I'm increasingly preparing for a situation where economic growth gets so weak that the Fed may be forced to cut rates, paving the way for a second wave of inflation.

For example, looking at the ISM service and manufacturing indices, we see that both economic sectors are showing significant weakness, which is supported by very weak consumer sentiment due to sticky inflation and elevated rates.

Meanwhile, rates are elevated, with mortgage rates being at the highest levels since the early 2000s.

I believe we're on very thin ice here. This weakening economy is unlikely to be able to deal with these elevated rates much longer.

Another example is the labor market, which is now starting to gain downside momentum. U.S. job openings just saw the steepest decline in more than two decades.

Again, I'm not trying to paint a super dark picture here. I have zero shorts and buy my favorite dividend growth stocks on weakness.

However, I'm increasingly buying gold, as I want to own something that benefits from a scenario where the Fed needs to give up its inflation fight, albeit just temporarily.

Speaking of Fed expectations, I believe that one of the best indicators of gold is future rate expectations. The chart below ( not updated ) shows the relationship between gold and the two-year forward price of Fed Fund futures.

I recreated this chart using the just-launched soft futures.

This is what I wrote in my Newmont Corporation ( NEM ) article:

The chart below compares the gold price (black line) to the difference between March 2025 SOFR futures and one-month forward SOFR futures.

Essentially, SOFR is the replacement of LIBOR. It's a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities in the repurchase agreement ("repo") market.

If the line increases, it means that investors expect borrowing costs in the future to decline relative to the short-term outlook.

This hints at easing financial conditions, which is bullish for gold.

While gold tends to have outliers (the invasion of Ukraine was a bullish outlier), we can assume that a situation where the market expects rates to be lower in the future is very bullish for gold.

Right now, it looks like gold prices are working on a bottom, which could soon see increasing upside momentum. Please note that the technical analysis in the chart below is automated. I usually refrain from using technical analysis.

I just thought it was an interesting development in light of weakening economic indicators.

Having said all of this, there are many ways that lead to Rome.

As I do not buy physical gold for safety reasons (I'm not anonymous), I prefer gold miners.

I buy gold miners with steep reserves, mines in safe jurisdictions (limited geopolitical risks), and efficient operations.

One of my favorites is Agnico Eagle Mines ( AEM ) .

I covered the stock a while ago, in June. Since then, a lot has happened, which has finally caused me to jump in and open a full position in AEM.

What Makes Agnico Eagle Mines So Special

With a market cap of $24 billion in New York, Agnico Eagle is one of the largest miners in the world.

Headquartered in Toronto, Agnico Eagle operates mines in nations with safe and predictable jurisdictions.

While not all miners with exposure in South Africa, Asia, and Africa are in trouble, I prefer to avoid miners who could be pressured by foreign governments. The risks of that could rise if commodity prices take off. We've seen these developments in copper and lithium segments in the past few years.

In the second quarter, the company produced 873.2 million ounces of gold, generating $975 million in operating income. 78% of this was generated in Canada.

Cost efficiency and financial metrics were also impressive, with the company exceeding guidance expectations.

Total cash cost per ounce in the second quarter came in at $840, surpassing guidance by $25, while all-in sustaining costs stood at $1,150, $15 below the midpoint of the guidance range.

These improvements were supported not only by the weakness of the Canadian dollar during the quarter but also by a robust operational performance.

The company also has a solid balance sheet.

Despite drawing roughly $1 billion on the credit facility in the previous quarter for the Canadian Malartic acquisition, the company managed to repay $900 million of that debt in the second quarter.

Hence, the balance sheet remains strong, with $433 million in cash. This is a decline of $300 million from the first quarter.

However, the net debt position improved to $1.5 billion, and overall liquidity increased to $2.1 billion.

The company enjoys a BBB+ credit rating, which is one step below the A-range.

Having said that, during its second-quarter call, the company highlighted what it believes to be key drivers for growth, emphasizing the potential of existing sites.

• Canadian Malartic's updated study highlighted extended production and significant geologic upside.

We talked about the additional ounces, the additional years, the potential there. But really what's exciting more than anything is the significant geologic upside that we continue to see there. That is a fantastic asset. - AEM 2Q23 Earnings Call

• Detour Lake's progress is aimed at reaching a million ounces a year by combining increased mill throughput and higher-grade underground ore.

This is a mine that's already out to 2052, that is still going to be increasing, and to get it to a million ounces a year, it's going to be a combination of increasing the mill throughput and bringing in higher grade ore from the underground. And we're working on that, and we'll be looking to give some updates in the first half of next year. - AEM 2Q23 Earnings Call

The company also shared insights into optimizing other assets like Macassa, Upper Beaver, Wasamac, and Amalgamated Kirkland.

These projects, utilizing existing infrastructure, hold the potential to add 350,000 to 450,000 ounces per year while reducing permitting risk and environmental impact.

Valuation

I often mention it, but commodity-focused stocks are tough to value, as they are highly correlated to the commodities they produce. In this case, that's gold.

Looking at the chart below, we see that AEM is highly correlated to the price of gold. However, recently, the stock (like its peers) has been in a downtrend, which is amplified by sticky production cost inflation and other issues that do not apply to physical gold investments.

Right now, the company has a consensus price target of $66, which is 35% above the current price.

The company is trading at 6x NTM EBITDA, which is well below the smoothed median close to 9x EBITDA.

I believe once gold rises, AEM will have the benefit of a higher multiple and higher expected EBITDA, providing a lot of potential upside for its share price.

In my NEM article, I made the case that the stock could triple in the years ahead. I believe that this applies here as well.

I have a longer-term gold target of $3,000, which would boost EBITDA by high-double digits without incorporating higher output and production efficiencies.

However, I do not expect this to happen soon. This could take 2-3 years to unfold.

Hence, I do not expect to sell my AEM position anytime soon.

Also, if you are looking to invest in gold mining stocks, be aware of their volatile behavior. Do not go overweight in these investments.

Takeaway

In a world where economic uncertainties are on the rise, I'm diving back into gold (miners). My conviction stems from the mounting risks that could force the Fed's hand into rate cuts.

While I've long advocated for extended inflation and economic strength, my current focus is on the potential weakness that might push the Fed towards rate cuts, setting the stage for another wave of inflation.

Given weak consumer sentiment and a shaky labor market, I am investing in gold to strategically boost my portfolio. By monitoring gold's correlation with future rate expectations, I am predicting potential shifts.

My sights are set on gold miners, particularly Agnico Eagle Mines, thanks to its robust balance sheet, efficient operations, and growth drivers. With a keen eye on gold's trajectory, I anticipate AEM's potential to thrive as gold regains its shine.

While I'm not painting a doomsday scenario, I'm positioning for a world where gold becomes a hedge against new inflation risks.

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