Friday, August 21, 2020

Berkshire Bought a Tiny Gold Mining Stake - Should We?

In the wake of Berkshire's purchase of Barrick Gold, a friend wrote up some thoughts about gold miners:

Buffett’s purchase of [Barrick] is interesting and suggests this could be the start of a new investment cycle for gold miners. I think there have been two major cycles previously and this one looks like it could be different. For a good part of the last century, until 1975, it was illegal to own gold bullion, so investors who believed there would be inflation and wanted exposure to gold could only get that exposure by owning gold miners, which were trading vehicles that were habitually overvalued. More recently in the 2000s commodity super cycle, gold miners were not good investments. Investors anchored to historical (overvalued) metrics from the days before bullion ETFs as an alternative were proved wrong. More importantly, gold miners were not good absolute or relative return investments because their costs went up in line with gold prices, partially due to falling grades but mostly due to higher input costs - labor, tires, and especially diesel. But this time, it could be different (dangerous words for sure). The price of gold is rising due to inflation expectations, but the cost of labor is falling - especially due to automation - and the price of fuel and other inputs has also fallen. Perhaps gold miners with established operations and falling costs will now benefit operationally and have a “moat” for some time due to a dearth of upstream exploration spending, partially due to cannabis and crypto replacing that sector for Canadian investors. 
This is something to think about. We don't love gold the metal because at $2k per ounce it is trading for about double production cost. You can see that in Barrick's Q2 2020 results presentation:

A million Au ounces per quarter is $2 billion of revenue and $1 billion of profit at their claimed cost of $1k per ounce. Market capitalization of $53 billion does not seem to imply a sustained $4 billion of annual profit.

And their 2020 guidance is actually for 5 million ounces of Au with a cash cost of $650-700 per ounce. (Which further underscores how overpriced gold is and how profitable a major miner is going to be.) Note that they also sell 500 million pounds of copper but they only make about $1 per pound at $3 copper, which makes this business a sideline to gold, at least at this gold price.

More than half their gold is produced in North America, with most of that coming from gold mines in Nevada that are joint ventures with Newmont Corp. Something kind of amazing is that the ore concentration is in the single digit grams per ton. That's on the order of one part per million, an incredibly small concentration. Amazing that they can wring that gold out of that rock for under $1,000 per ounce. An ounce is 28 grams, so to recover an ounce of gold they have to process 28 tons of ore. And for every ton of ore, they seem to have to also move 6 tons of waste. So an incredible amount of digging and moving - and yet, so cheap.

Some recent links regarding gold:
  • Central planning requires central money, and gold stands apart by its very decentralized nature. It is indifferent to human conceptions, and can be discovered and summoned from the earth only with tremendous risk and effort. It cannot easily be manipulated or destroyed, and its value cannot be decreed (though they try mightily). It is unchanging, unyielding, and stubbornly at odds with the political visions of Fed bugs. And so they hate it. [Deist]
  • Just try to buy a deep freezer or pressure canner these days. They’re all sold out and on back order for months. The price of canning jars and lids has more than doubled since the Big Cooties hit five months ago and they aren’t always available. Emergency preparedness websites were picked clean in the early days of the Covid freak out and are only now partially catching up as supply chains wobble. I cringe as folks rush to buy gold at all time high prices in a panic as if it had talismanic powers. What good will a few Krugerrands do if you have no food in the house and the store shelves are bare? [Granola Shotgun]
  • The chart peaked in 2000, which was really the peak in worldwide optimism. Not just tech stocks, but world peace, world trade, and a bunch of everything else. Then the optimism faded for over a decade amid terrorism, war and a financial crisis. The ratio started rising again in late 2011 which is also when the U.S. housing market started to rebound. What's also interesting -- and clear in retrospect -- is that the optimism cycle that started in 2011 didn't just come to a screeching end in early March. The optimism cycle ended in the middle of 2018. This was in the wake of the tax cuts (late 2017) and the early 2018 budget deal, which actually boosted spending substantially. Not only did the stocks/gold ratio peak then, but so did the Russell 2000 small cap index, which never regained its 2018 peak. An overlay of the stocks/gold ratio against small cap stocks is shockingly consistent. [Joe Weisenthal]
  • The banks in San Francisco (and even banks "back home" in St. Louis and New York) were getting in constant jams because of fractional reserve banking. One thing I hadn't realized is that San Francisco business conditions were levered to the amount of gold coming in from the mines, and the amount of gold mined was, in the short run, a function of rainfall. (Water being used to separate the gold from dirt.) In the long run, of course, the gold production decayed steadily as the most easily discovered and extracted deposits were mined. The "Hubbert's Peak" for California gold was in 1852, before Sherman's bank was even set up. [CBS]
  • American Eagle gold coins are selling for $200/oz over spot! When I last bought kruggerands (almost 20 years ago), they were at a discount to spot. In 2008, I bought tarnished silver eagles for a discount to spot. Now, silver eagles are selling for an $11 premium to spot - that's 70%!  As I put in in 2011, a better inflation bet than gold and silver coins is to hoard nickels, because you have a put option at your cost of five cents.  Silver is down more than 50% nine years later, even at the current exorbitant premium to spot. Gold is down maybe $100/oz or so. But the nickel is still worth a nickel. [CBS]
  • Wikipedia says it's either 165,000 or 174,100, PIMCO said 155,000, and the goldbugs think it is less due to exaggeration and double counting of paper gold. Call it 150,000 metric tons. That's 4.8 billion ounces. Only 2/3 of an ounce per person on Earth is the "fair share". So it would be pretty trivial to own a multiple of your fair share of gold. Incredibly little per person! There are about 12 million square miles (8 billion acres) of arable land in the world. That's just over one acre per person. The U.S. has about a million square miles, or 640 million acres, of arable land, which is just over two acres per person. M1 money supply is about $8,000 per person in the U.S. and M2 is $30,000. Try getting $30,000 in cash from a small bank branch someday. If oil reserves are 1.5T barrels (generous) than the amount per person is 250 barrels. You could buy that for the price of a decent car. The deliverable on an oil futures contract is 1,000 barrels and the initial margin for that contract is only $4500! There's only one cow for every three people in the U.S. What I am getting at is: it probably wouldn't be a bad idea to own more than your fair share of all of these resources. [CBS]


Stagflationary Mark said...

“Now, silver eagles are selling for an $11 premium to spot - that's 70%! “

I wonder how much of this has been driven by toilet paper shortages. In 2004, I was hoarding both toilet paper and silver as we were heading into the obvious housing bust. Silver went parabolic then. It’s gone parabolic again.

This time, it is more than just me hoarding toilet paper. I thought about buying silver earlier this year but was too chicken to risk it. Missed opportunity. No desire to buy it now.

I’m not worried about toilet paper long-term. I have no doubts that it is being cranked out at sufficient pace to eventually satisfy every American. For the longest time, none could be found online at Costco. That’s no longer the case. I could order more right now if I so desired. I don’t. I had plenty heading into the pandemic and I am merely maintaining my supply (buying at a normal pace).

Unsustainable hoarding eventually leads to increased production. Increased production eventually leads to gluts. This is hardly news, of course. We keep seeing it over and over again. It’s the very same mechanism that dotcom stocks experienced in the late 1990s. The markets produced too many of them because investors wished to hoard them. Housing was no different. Gold and silver too.

Here we go again.

I have a lot of aluminum foil from 2004. It was something I knew I would eventually need and interest rates were rock bottom. I’d buy every time there was a sale at Costco. I stopped doing it when I walked into Costco one day and saw a huge stack of aluminum foil, and to nearly quote Dune, “the likes of which even God hasn’t seen.” I have no regrets over buying aluminum foil. I still have no desire to buy more though. That said, I’d rather buy aluminum foil right now than silver. Same reason I had the last time silver went parabolic.

Has hindsight ever been kind to those panic buying silver? Maybe it’s different this time, but I strongly doubt it.

CP said...

And boomers are the ultimate unsustainable hoarders.

whydibuy said...

All while ignoring Buffett cutting stakes in banks.
Banks have been big beneficiaries of a ever expanding debt society. Buffett is saying that is over. With little to no debt growth, banks will be the dead zone for years to come.
And just to scale the Buffett gold buy, its a meager 400 mil. Small potatoes to berkshire.

Allan Folz said...

Berk's allocation on Barrick is well below the level at which Buffett is personally involved.

Personally, I don't think Buffett made this call. His style is buy significant quantities, if not the entirety of a company. Further the companies are either some de-facto standard or oligopoly central to the economy. Doubly-so if they have a regulatory moat that he can influence with Congressional lobbing and subsequently game for returns that are many multiples of his lobbying dollar.

I don't see how gold miners fit into that model.

tony said...

I appreciate your perspective. The resources you mentioned are all genuinely scare with the exception of M2.

tony said...

I appreciate the perspective. The resources you mentioned are genuinely scarce with the exception of M2.

CP said...

Also scarce:

Clorox wipes
pennies & nickels

Allan Folz said...

Breaking: Berk's Big Money ($5B) purchases (ie. Buffett's direct involvement) did NOT include gold or gold mines. ;)