Looking at Gold Miners

Last week, we mentioned Gold Miners and the Net Issuance Anomaly. The gold miners are profitable, have low debt, and are paying dividends and buying back stock. Investors were slow to respond when the airline industry consolidated down to four players with better discipline - until Buffett, who had always badmouthed the industry, bought big stakes in all four of them at single digit earnings multiples.

Mining (and maybe especially gold mining) has been a long bear market. The gold miners ETF (GDX) has been in a bear market since 2011 - a decade! - and is trading where it was 15 years ago. The junior gold miners ETF (GDXJ) is trading for half of what it was at inception in 2009.

Producers of natural resources - energy and metals - have the worst trailing performance of all the industries in the entire economy. Trailing performance this poor means that they should be cheap:

A fund manager might have a huge number of very cheap stocks they would love to buy, but if they do not have any available cash, they do not get to 'vote' on the market price by buying in the open market, as they lack the liquidity to do so - in the short term at least (longer term, you can reinvest dividends). Furthermore, if the said manager is suffering investor redemptions due to recent returns being poor, then regardless of the underlying managers' views on the long term attractiveness of individual securities, they will be forced to sell. It is therefore not uncommon for those most informed about the opportunities in undervalued securities to be actually selling them rather than buying, in direct contradiction to the EMH.

The market cap of Dogecoin ($31 billion), the sixth most valuable cryptocurrency, is twice the AUM of the GDX ETF. I would much rather own the entire energy production, energy transportation, and mining industries than all cryptocurrencies and the Robinhood 19 stocks (probably about $4 trillion combined!) Let's look at some possible gold miners.

• Kirkland Lake Gold Ltd (KL) - market cap is $10 billion. They have no net debt. In 2020 they made $1 billion net, selling gold at an average price of $1.7k per ounce. They had $1.6 billion of operating cash flow, spent $582 million on capex and $848 million on share repurchases and dividends. They say that $400 million of last year's cap ex is "sustaining", so that would mean FCF of $1.2 billion or a 12% FCF yield. It's a shareholder yield (dividends + repurchases) of 8.5%. 
• Gold Fields Limited (GFI) - $9 billion market cap, plus about a billion of net debt. They made $745 million net in 2020. They generated $1.3 billion from operations, spent $584 million on capex.

We also like the business model of Royal Gold as mentioned in our original value post last fall. I think a basket of these gold miners is cheap and adds diversification to similarly cheap investments like tobacco companies, oil and gas royalties, and pipelines.

Gold Miners and the Net Issuance Anomaly

From Crescat Capital's March 2021 letter:

Gold and silver companies continue to report exceptionally strong fundamentals. Free-cash-flow estimate for miners keeps improving despite the recent correction in precious metals. As we have seen throughout history, stocks tend to follow fundamental growth. We believe there is a major catch up in prices ahead of us. There used to be a time when all gold and silver miners would do was to invest in unproductive assets and dilute their capital structure to pay for it. Those days are over. For the first time in history, aggregate net equity issuance for the top 10 precious metals mining companies is now falling. In other words, these companies are buying back stock like we have never seen before. These are fundamentally cheap stocks that continue to benefit from this macro environment.

I'm a believer in the taking advantage of the net issuance anomaly (i.e. companies retiring debt and repurchasing shares outperform those raising capital).

Where does the anomaly show up today? Industries with companies that are returning capital to investors are banks, tobacco, energy, miners, pipelines. Industries that are raising capital are electric vehicles and many types of growth and tech - especially considering stock based compensation. (Although some tech is negative issuance, e.g. Apple.)

The net issuance anomaly is related to our Sector Rotation Value Strategy. One logical mechanism which would cause the net issuers to under-perform is that they are in the "over-investment" part of their industry cycle. They take the proceeds of their equity and debt issuances, and they expand capacity, driving each other's economic rents down.

Back in May 2014, I did a large cap value screen. It was based on highest trailing 10 year earnings yield and shrinking share count. The top 15 candidates were:

Apollo Education (APOL) - this went private, would have lost money
American Financial Group (AFG) - this has doubled
Coach, Inc (COH) - now TPR, this is flat
ProAssurance Corp (PRA) - got cut in half
The Gap (GPS) - down about 25%
Magellan Health (MGLN) - up 50%
Bed Bath (BBBY) - down 50%
Exxon (XOM) - down about 25%
Intel (INTC) - doubled
Microsoft (MSFT) - up 6x!
Murphy Oil (MUR) - down 2/3rds
Chevron (CVX) - flat
Apple (APPL) - up 7x!
Occidental (OXY) - down 2/3rds
Marathon (MRO) - down 2/rds

If you had owned them equal weight (6.7%), the Microsoft, Apple, and Intel positions would have returned your whole fund. However, the energy stocks killed the overall return. 

Maybe the key here was that the earnings yield didn't account for capital structure the way the "acquirer's multiple" (EV/EBIT or EBITDA) would.

The other thing is that with the acquirer's multiple, you don't just hold for 7 years but rotate every year to whatever is screening cheapest. So you wouldn't have held the oil (and also probably not the tech) this long. Now you would be in tobacco and mining companies!