John Hathaway: if you think gold price will hit new highs, just watch what gold miners will do
Any move towards a true, fair value for gold bullion would only be magnified in gold mining stocks, according to John Hathaway, senior portfolio manager of Sprott.
“If gold is not correctly priced for what has transpired and what lies ahead, gold mining stocks are even more inappropriately priced,” Hathaway said in a recent Sprott report.
Hathaway said that the gold mining sector is the only industry that stands to reap strong, positive earnings in 2020 and 2021.
“2020 free cash flow yields for large-cap producers range from 3%-7% and 6%-25% for intermediate producers based on conventional sell-side research. The stats are similar or better for 2021 based on spot gold prices,” the report said.
Although it is true that the mining sector has suffered from mine shutdowns and other shortfalls this year due to COVID-19, much of this is already priced into the market, Hathaway said.
Additionally, Hathaway noted that since 2008, gold equities’ relative valuation to gold bullion has already fallen 75% from the prior 25-year average.
Hathaway based his prognosis on the fact that unlike other industries, the gold mining sector would not suffer from a depreciation of value on their underlying product.
“Unlike the airline, leisure, retail and manufacturing sectors, gold not produced today should grow in value and be produced at higher prices and lower costs next year and those beyond. It is not the same story for many other sectors of the economy,” he said. “Based on fundamentals, gold stocks are inexpensive. By contrast, several other sectors of the economy could face long stretches of poor earnings, bad news flow and financial woes.”
Importantly, gold mining stocks stand to benefit tremendously from a gold-bullish macroeconomic environment, which historically has seen gold stocks lever their rise relative to gold bullion.
“In a favorable cycle for the gold price, mining stocks have historically delivered outperformance 3 to 5 times that of the metal itself,” the report said.
Good times ahead for gold
The full scale of consequences of unlimited quantitative easing from the Federal Reserve are yet to be observed, but one outcome could be the obsolescence of fixed income as a safe haven asset, Hathaway noted.
“The risk parity trade has fallen short, partly because bonds were caught up in the indiscriminate liquidations of Q1. Looking forward, bonds may no longer be able to play the safe haven role they traditionally filled to balance equity risk,” the report said.
If this were to happen then, gold’s demand would increase as the yellow metal steps in to fill the vacuum left by bonds, Hathaway added.
So far, there is still room for gold to gain mainstream acceptance, he said.
“Gold is extremely under-owned, under-represented, and poorly thought of in the circles of conventional investment thinking. It is still considered to be a fringe asset,” the report said.
Unprecedented fiscal and monetary stimulus, which Hathaway referred to as “policy damage,” will erode value for equities and bonds regardless of which direction inflation heads to.
“What seems quite apparent is that traditional Keynesian stimulus measures are in their endgame. They will most likely deliver only steadily diminishing returns. Starkly opposite economic outcomes are possible from this policy morass; both would be positive for gold but negative for real returns on fixed income or equities,” he said.
The end result is gold prices never before seen.
“Gold is on the cusp of breaking out to all-time highs in U.S. dollars and has already done so in virtually every other currency. Gold mining stocks continue to lag the metal and, in our opinion, represent a compelling investment opportunity at this moment,” Hathaway said.