2023-03-27 17:00:40 ET
Summary
- My argument/analysis of why gold makes sense.
- Why belief is more important than analysis for gold.
- An example of Newmont Corporation's upside potential at $2,500 gold.
Question #1: If gold goes to $3,000, then what happens to gold mining stocks?
Question #2: If we don’t reach $3,000 but get close, what happens to gold mining stocks?
The answer to those two questions is that gold mining stocks will have epic returns.
Let’s use one gold mining stock as an example to consider what could happen.
Current Valuation
Newmont Corporation (NEM) (NGT:CA).
Current FD market cap: $38.8B
Production: 6M oz.
FCF (free cash flow): about $500 per oz.
Annual FCF (at $1,900 gold): about $3B
FCF multiple: about 13 ($3B x 13 = $39B).
Future Valuation
Let’s use a future gold price of $2,500.
Production: 6M oz.
FCF margin: about $1,000 per oz.
FCF: about $6B
FCM multiple: about 18 ($6B x 18 = $108B)
Return: about 180%.
This is just a hypothetical return. The key assumption is that their free cash flow multiple will explode from 13 to 18. Perhaps it will only rise to 15, but with higher margins, the multiple will clearly increase. And if there is a mania in PM mining stocks, the multiple has a good chance of reaching 18.
Okay, so one of the largest gold miners has the potential of having a 180% return at $2,500 gold! And what happens if gold continues to run to $3,000? Even higher returns.
Guess what? Newmont Corporation isn’t even on my radar as a stock to own (except in gold mutual funds and exchange-traded funds, or ETFs). Why not? Because if Newmont has that kind of potential return, what kind of return can I get for a mid-tier or development gold mining stock?
This is why I only look for 3+ baggers. There are many to be found.
But enough about potential returns. Let’s look at why gold can reach $3,000.
The only reason to own gold mining stocks is if you are a believer that the U.S. economy is on the precipice of a major crisis that will engender a high degree of systemic risk. Why? Because PM mining stocks have too much risk as a normal investment. They are speculative investments, and as such, they need to provide high returns to be worth the risk. Moreover, the only way you will get a high return that is commensurate with the high risk is for a systemic risk event to occur.
The gold market is huge and is one of the largest markets in the world. Gold bullion alone has a market of around $4 trillion. The only way you get a market of that size to move substantially higher is for investors who normally avoid gold to suddenly want to own some. This group of investors includes the big money players. They are the Wall Street investment banks, hedge funds, pension funds, insurance companies, and the 1% crowd. This group is normally content to own stocks, bonds, and fiat currencies. The only way they will swap these assets for gold is if systemic risk reaches a high enough level to jeopardize these assets.
This is Exter’s Pyramid:
Exter's Pyramid (www.goldstockdata.com)
Money will move to gold if the risk is too high for all other assets. Remember above when I said that you need to believe that the U.S. economy is headed for a crisis? Well, this chart clearly shows why belief is so important. For instance, why would investors ever buy gold? Why wouldn’t they just stay in government bonds, money market accounts, and cash? That is a question you need to ponder.
Now let’s look at the reasons why investors could swap their other assets for gold.
1) MMT (modern monetary theory). This was invented by the Japanese after their epic economic crash in 1989. Instead of allowing their corporations to go bankrupt, the Japanese central bank lowered interest rates to zero and allowed them to exist as zombie corporations, whereby they didn’t generate enough income to exist but were subsidized by the government to keep their doors open.
Some of these zombie corporations were banks or financial institutions. By keeping them alive, they essentially created a fake/managed economy. Then to prevent it from imploding, they started printing money. In 1989, Japan’s government had little national debt. Today, their national debt is more than 200% of their GDP. MMT essentially is the philosophy that debt doesn’t matter, and you can print whatever you need.
When 9/11 occurred in 2001, the Fed looked at what the JCB (Japanese Central Bank) had been doing and decided they would emulate it. We have been emulating it ever since. Since 2001, have you heard of any legislation in congress to reduce the national debt? No, you have not. MMT is a Ponzi, and you can’t taper a Ponzi.
MMT has led to the everything bubble. It has led to the reliance on low interest rates and monetary (mouse-click money) expansion. It has also led to inflation, which is its Achilles heel. But more significantly, it has led to the end of the free market and price discovery (the ability to accurately value a stock or company). All we have left is central bank manipulation in tandem with government programs and regulations. In a very stealth-like manner, the government has become highly involved in the U.S. economy. And when has the government ever gotten anything right?
MMT is insanity economics. If you think it isn’t, then don’t buy any PM mining stocks.
2) Politics. The U.S. political system is not only broken, but can’t be fixed. Not only do the Democrats and Republicans no longer talk to each other, but they have now become so polarized that political discourse has essentially ended between them. All we have today is an all-of-nothing agenda. Each side is going it alone. The Democrats want to create a new America that has little resemblance to the past. The Republicans want to hold on to an America that is slowly dying. If you look closely, you will see that neither side has answers to our problems, and those problems include our economic issues.
3) Global International Trade. From 1945 until 1970, the U.S. economy was the leader of the world, and the U.S. was a mercantilist country that sold products to the world and generated an abundance of wealth. That all stopped in the 1970s.
Then in the 1980s, the Reagan Administration realized that we had to try something different to maintain and grow our standard of living. We adopted globalism and free trade. Unfortunately, since we stopped making things (such as electronics, appliances, clothing, etc.), we had to use debt to offset this income. Since 1980, the U.S. debt has risen from less than $1T to over $30T.
Essentially, beginning in 1980, the U.S. as a country began running up its credit cards and living off of debt. We have been using MMT to kick the can down the road and relying on the U.S. dollar as the global reserve currency. This has allowed us to have other countries fund our standard of living.
If you look closely, you will see that these three reasons I have given are all closely related, and that the U.S. economy in many ways resembles a house of cards. If the U.S. dollar loses its preeminence as the global reservice currency, or if foreign countries stop buying our bonds, then it will be the end of U.S. global hegemony and the end of an era. And eras do not end without a crisis.
Are we at the end of an era? Is the Fed trapped without a way out? Will the BRICS+ nations begin using a currency other than the dollar for their global trade transactions? These are important questions. Your belief in them will dictate if you are a believer in a potential systemic risk event. Because if one occurs, then surely gold will make its way to $3,000, and those two questions that I asked at the beginning of this article will seem pertinent.
For further details see:
Newmont: Why Gold And Gold Miners Make Sense In 2023