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Gold-mining shares still 'cheap' based on historical metrics - VanEck's Foster

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Joe Foster

(Kitco News) - Gold-mining stocks remain undervalued based on the statistical norm of share prices to cash flow, and this is occurring at a time when producers are on their best financial footing in recent history, said Joe Foster, portfolio manager of VanEck International Investors Gold Fund (INIVX).

Valuation is one of the factors that Foster focuses on when picking stocks, and the market was “very oversold” when share prices of producers bottomed back in March, he said. Shares have have risen sharply since, yet valuations are still below their long-term averages, Foster said in an interview with Kitco News.

“It looks like a spectacular performance when you go from the bottom of the crash [in mining stocks] to where we are now,” Foster said. “But you have to remember, at the lows in March, stocks were trading at about five times cash flow. They are currently trading around eight times cash flow.”

Meanwhile, he continued, the long-term average is for shares to be 11 times cash flow. And during a strong bull market in gold, shares can get up to 20 times cash flow.

“So across-the-board valuations of these companies are relatively cheap compared to the historic averages,” Foster said.

The fund manager explained that the industry tends to monitor share to cash flow rather than a comparison to earnings, as is the case for the broader stock market. This is because of the “extremely volatile nature” of earnings in the natural-resources sector, making the comparison to cash flow more meaningful.

“You have to remember, stocks have risen, but the gold price has risen as well,” Foster added. “So you have to factor that into your valuations.”

As of 10:40 a.m. EDT, spot gold was at $1,720.80 an ounce, having recovered from a mid-March low near $1,450. As gold rises, of course, so do revenues for gold producers.

Foster also looks for “value creation” of producers when picking which stocks to include in the fund.

“The best way to create value is to take a worthless piece of real estate and turn it into a gold mine,” he said. “We find more of that type of value creation among the smaller companies – the midtiers and the junior companies.”

The industry is having an increasingly hard time finding new large-scale gold deposits, he continued. But smaller ones, in the range of 1 million to 3 million ounces, are still being discovered.

“When a company can find a deposit like that and develop it into a gold mine, obviously that creates a tremendous amount of value. So that’s what we’re looking for in the juniors and midtiers,” Foster said.

Meanwhile, with limited major new discoveries, the main avenue for the large senior producers to add value is to control costs such as good management and developing new technologies, Foster said. And in the current bull-market cycle, these companies collectively are doing a good job, he added.

“In a rising gold-price environment, what we want to see are rising margins,” Foster said. “We don’t want to see costs rising with the gold prices. We want to see costs remaining constant and we want to see their profitability increase in a rising gold-price environment. We want to see increasing dividends and increasing returns to shareholders.”

And, he continued, companies have done a “great job” on this front.

Gold mining sector healthy

In fact, Foster commented that the financial situation for gold-mining companies may be the best he’s ever seen in a long career that started as a geologist and later as a fund manager. That, he said, may be one of the most overlooked facet of the gold market among the general public.

“I’ve been in the gold-mining industry for all of my career. I don’t think I’ve ever seen it as healthy as it is today,” he said. “They’re firing on all cylinders. They’re doing a great job of controlling costs. They’ve got their balance sheets in pristine condition. They’re very well managed companies.

“I could not have said that five or 10 years ago. The industry leaders are Newmont and Barrick. They’ve been poor leaders in the past. But now, they’re genuine industry leaders, and it’s great to have that.”

Many generalist investors may still remember the period during the last bull market when many companies took on heavy debt and costs were “out of control,” Foster said.

“The industry has turned itself around 180 degrees,” he said. “I don’t think that’s appreciated or known across the broader investment community.”

Second COVID-19 wave would further support gold

Gold prices are higher than before the COVID-19 pandemic broke out. And the metal likely would benefit further if a feared second wave of infections occurs, since this increases the risk to the financial system and global economy, Foster said.

“Given what’s happened already, the financial system is already in great danger, in my view,” Foster said.

News reports say infections appear to be on the rise again in China, where the pandemic first occurred. Meanwhile, record infections are occurring in a number of U.S. states even as economies reopen.

“The pandemic has wreaked havoc on the financial system and has decimated the economy. If we have further lockdowns, we’re going to have more of the same,” Foster said. “Governments are already up to their necks in debt.”

Even though gold is up 13% for the year so far, Foster said the market has not risen enough to be near a top. He continues to look for gold to be at $2,000 an ounce sometime in the next year, with potential for much higher if all of the liquidity pumped into the financial system results in an inflationary cycle in the next two or three years.

“We’re in the middle of a secular bull market,” he said. “People need to realize that.

“The risks that the financial system and economy are facing today are unprecedented. The macro environment, with negative real interest rates, is very favorable for gold. And nobody expects rates to rise in the foreseeable future. So we’re in an environment that is supportive for gold, and the outlook is for that environment to continue for quite some time.”

2Q earnings somewhat meaningless

The calendar is approaching the end of the second quarter, with the next round of earnings reports for mining companies not far away. Foster said he will probably give less weight to the reports than usual.

For the most part, global gold production has returned to the levels from prior to the lockdown, he pointed out.

“It’s going to be a messy quarter, with all of the COVID-related shutdowns, mitigation and everything that’s gone on with the pandemic,” he said. “I’ve almost discounted the second quarter as somewhat meaningless….I think most investors are looking through the second quarter into the third quarter and beyond.”

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