I wanted to take a moment and share my thoughts this weekend about being shareholders in gold and silver miners and tell a couple stories I have heard over the years from the old school guys that were before my time in the industry. I think these examples are extremely relevant today for precious metal miners and for us, as shareholders in them. Some of you may know these stories or have heard arguments for their implementation before in the PM sector, but for those who haven’t, a little history…
(I was surprised that after a quick google search there are still press releases about this over 15 yrs later, so you can look it up and find some more details.)
Goldcorp was founded in 1994 by Rob McEwen. By 2000, they had
become one of the biggest gold miners in the world at a time when gold was
about to transition into a bull market.
McEwen was very bullish on gold and an exceptional CEO who made incredibly
bold choices that set them apart in the industry and grew them into such a big
competitor to the other major miners. In
2005, while gold was once again butting heads with the $400 level where it consistently
was being pushed back from, McEwen believed it was headed higher, closer to
$800 an oz.
Now here is a lesson in good management, bold leadership,
and bad management, where bad decisions typically begat more bad
decisions. For years as gold would tap $400,
Barrick took advantage of this by hedging a portion of their future production
by selling it at that price. For years
this worked, and Barrick made a few billion in extra cash through this method
but became complacent, outstayed their welcome and overleveraged their reserves. I believe by the early 2000s they had hedged around
20% of all of their reserves at ~$400/oz.
In the meantime, Rob McEwen was a gold bull believing the end to a 2-decade long bear market was coming. His thought process was this: If I think gold is headed higher than the current price near $400 an ounce, why should we sell our gold at $400 an ounce?
So, he didn’t. By
2005, Goldcorp was withholding their production from the market. About 31% of their Q3 production in 2005 - which
is a pretty massive amount - they stockpiled. Rob McEwen even said at the time
that with their cash reserves, they could stop selling ALL the gold they
produced for 2 full years and still be able to cover their dividend
payments. (Goldcorp was one of few
companies that paid a dividend every month.
On dividend reinvest, it compounds faster than quarterly payments). Gold soon broke above 400, and went on to a
high of ~720 the following year. Then,
Goldcorp dumped their horded ozs on the market at a price that was significantly
higher than market price at the time of production and it gave them an
exponential increase in their profit margins. This of course blew away earnings estimates
and sent the stock soaring. Anyone
foolish enough to have been shorting Goldcorp had their heads handed to them
and likely vowed they would never short Goldcorp again.
Back to Barrick. While
this is going on Barrick begins realizing they’ve screwed themselves by selling
so much of their gold at 400 as prices were rising to nearly double that, and
costs were rising quickly as well. Obviously,
their profit margins were razor thin and dropping faster as oil - which is typically
a gold miner’s biggest cost - began pushing above $100 a barrel in 2007. So, in order to not see all profit evaporate for
their incredibly bad hedging decision, they decided to make another one. This time by hedging a portion of their 2008 oil
cost at ~100 a barrel. By 2008, oil had
dropped to $30 and Gold had risen to 1000/oz.
Having been dead wrong on both their production hedges and cost hedges, which
destroyed billions in shareholder value over years, Barrick threw in the towel
in 2009 and issued $3 billion in stock to pay off the remaining 9.5 million ozs
it had left hedged. In return for the
poor performance shareholders suffered during the beginning of the bull market due
to management’s bad decisions, management rewarded them by diluting shareholders
by 12.5%.
(This, in short, is why I have never in the past, or ever
will in the future, be a Barrick shareholder)
But back to Goldcorp and the concept of withholding production. For the past few years this has been an
impossible concept for any miner, as margins and cashflow were so thin. Today, that’s not the case anymore, with gold
miners seeing their largest profits ever at these prices and silver miners
seeing margins increase in some cases by 1000% at prices today near $25/oz. The idea of withholding a percentage of
production can absolutely be a reality for some mining companies.
The idea however is not very likely considering management of
some companies. You would need bold
leaders who believe in a bull market in PMs and are not afraid to lean into the
bull market and think outside of the box for ways to make their companies more
profitable. This is not something that
is likely from say, Newmont. While
Newmont has believed in higher metals prices, as the only Gold Miner on the
S&P-500, they have typically refrained from making extreme calls on future metal’s
prices or embarked in unconventional business practices as to not alienate
investors. But I can think of some
silver mining companies that certainly have the ingredients, including bold management
and leaders who believe in higher silver prices, that can pull off an incredible
move like the one Rob McEwen did in 2005.
A silver miner, mining at a cost of $15 an oz has a $10 profit
margin today with silver at 25. If
silver climbed back to $30/oz, it would be 20% higher than the silver price
today but the profit margin for the miner would increase by 50% to $15. And that’s only selling at a price that is
20% higher than right now. McEwen did
this at prices that were nearly 100% higher.
At $10 profit per oz, a silver miner can increase their annual profit by a full 10% by withholding 20% of
their production and selling it at 30/oz, assuming the other 80% is sold at 25/oz.
And again, this is at only 20% higher prices
than where we are now. I fully expect
that if a silver miner has enough production and cash flow to pull this off, they
can sell at $40/oz, increasing their profit margin 150% from $10 an oz, to $25
an oz. That would equal a 30% increase in
total annual profit vs selling all ozs at 25.
There is a silver lining here too (no pun intended). By doing this, short sellers in PM stocks
could be in for a world of hurt, as they were when Goldcorp did this in 2005. It will make forecasting their profits far
more difficult and effectively make the Due Diligence the short seller has to
do, far more complicated if not impossible. Announcing to the market that management has
decided to withhold 10-20% of their production until they feel prices are
better valued than they are today would be enough to shake a significant number
of short sellers out of their positions.
This could be very beneficial for any company that is currently struggling
with the problem of a large short position in their shares.
But here comes my favorite part. You could just NOT tell them. There is no reason you HAVE to inform the
market that this is what you plan to do.
You could just let them find out on your next earnings release. It’s amazing how pain sticks with us as
humans. Do something that hurt
significantly, and you are unlikely to do it again. Get blown away on a short position on a PM
stock, and if you are ever bearish again on PM miners, you’ll absolutely choose
another company in the sector to short next time around, or avoid doing so
altogether.
As PM mining share investors, we are lucky because there is
a common theme among us. We typically
all own these shares because we believe metals prices are going higher. Sure, there are individual growth stories,
but most are not investing based solely on a single company’s story that has no
relation to a rising metal price. This
is not necessarily the case for say, Apple shareholders or many other companies
in different industries. This is
important, because we are the owners of the company and we have a consensus where
we believe in higher metals prices. Management’s
job is to do what is in the best interest of the shareholders. So, if you own shares in mining companies,
take the time to contact them and ask them this:
-Do you believe the price of gold/silver is going at least moderately
higher from today’s prices?
-(I believe a decent margin of these companies would answer “yes”)
-Then why are you selling all of your gold/silver at today’s
prices?
As I mentioned, this is a very out-of-the-box idea. Mining companies are in the business of
pulling metal out of the ground and selling it, not storing it or speculating
on future price movements. There are few
if any companies that would be willing to adopt such an idea. But it has been done in the past and done
very successfully. The result was
developing Goldcorp into a leader in the gold sector, rivaling major producers like
Newmont just 15 years after its start.
(Worth noting, Newmont who ultimately bought Goldcorp, is 100 years old
this year, founded in 1921.)
What we need today is a leader in the PM space. A production withholding policy would be a
game changer that will be the envy of every PM mining investor. I believe shareholders have a consensus with
their beliefs about metals prices and would support such a bold move. Management works for us shareholders. If you believe a policy like this will
benefit the company and shareholders, let the concept of withholding part of their
production from the market become our battle cry. Ask the companies you’re invested in why they
are not doing this. There is an
incredible opportunity here and I believe someone will take up this flag and
run with it and be rewarded with increased profits, an army of loyal and very happy
shareholders, as well as a mass exodus of short sellers in their shares.
History doesn’t always repeat, but it can rhyme.
-Jonathan Mergott
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