Published: April 8, 2024

By: Philip MacKellar

Are lagging mining equities about to catch up with commodity price performance?

Over the past six weeks or so, precious metals exchange-traded funds such as the VanEck Gold Miners ETF and the VanEck Junior Gold Miners ETF have rallied sharply, after a multiyear period when miners lagged the price of gold and even silver.

The disconnect between the commodities and the companies has a lot to do with factors such as inflation, labour costs and supply chain disruptions. This is because these forces eat into corporate profits but have no impact on the value of the underlying commodity. Over time, however, businesses should be able to adapt to these pressures, improve profitability, and narrow or eliminate the performance gap.

So far, our answer to the question has been maybe – but it depends on what happens next. If gold and silver prices continue to climb and mining costs decrease, then miners should do well. Even if commodities flatline but cost pressures abate, mining companies should see their shares rally. If, however, gold and silver decline, or mining costs continue to escalate, then the equities will most likely lag or fall.

From this angle, the odds seem to favour stable or rising precious metals prices. According to gold.org, central banks have been buying bullion aggressively since 2022. Gold miners have also underspent on capital expenditure and exploration for more than a decade, and gold reserves remain around 35 per cent below where they were in 2011.

These influences could affect future supply – especially if central banks continue to buy bullion. Moreover, the rally in gold has occurred despite competing with cryptocurrency as a supposed store of value, and despite signals from the U.S. Federal Reserve that it will be in no rush to cut interest rates this year.

Perhaps most important of all is that precious metals, especially gold, often do well in beaten-up stock markets and during times of panic, geopolitical flare-ups or financial distress. Though there are certainly current geopolitical tensions such as the wars in Ukraine and Gaza, these have been known quantities for a while. For precious metals to perform so well in the absence of panic or distress suggests they are in a good position if – or when – markets turn downward, fear re-emerges or panic sets in.

In our portfolio of 28 names, we own four precious metals miners. Pan American Silver Corp. PAAS-T +3.06%increase is one of these and is currently the most interesting of the four. We have owned Pan American since it teamed up with Agnico Eagle Mines to acquire Yamana Gold. This transaction was completed in March, 2023.

Like many of its peers, Pan American’s stock price has not kept pace with the price of gold and silver. Over the past year, its shares are down nearly 4 per cent, while gold and silver have both posted gains in the mid-teens. Pan American has generated a dividend during that time, but the total return of the stock versus the commodity is not in question.

The company’s 2023 financial results missed management forecasts on a variety of metrics, including for silver production, silver cash costs per ounce and gold cash costs per ounce. This rippled through to the financial statements. It met its top-line consensus analyst estimates, but tanked compared with bottom-line forecasts.

All in all, Pan American lost US$132.2-million, or 32 US cents a share, in 2023. The company did suffer operating losses, but most of this red ink was caused by three charges: a US$16.5-million revised depletion charge, a US$36.2-million crushing and agglomeration plant impairment, and US$13.8-million in closing and decommissioning expenses.

The outlook for 2024 is also mixed. Gold production is expected to increase by the low- to mid-single digits, silver output should be stable, and all-in sustaining costs (AISC) for silver are estimated at between US$16.00 and US$18.50 an ounce, versus US$18.17 last year. This said, the gold AISC of US$1,411 an ounce last year are projected to jump to a range between US$1,475 and US$1,575 in 2024.

So, why is this stock so interesting? Well, it is cheap. It is so cheap, in fact, that Pan American has one of the largest gaps of any mining company between the current share price and the analyst community’s consensus 12-month target price. As of April 8, Pan American has an average 12-month target of $30.95 with four strong buys, four buys and one hold. If the stock hits this target, it would net a 26-per-cent gain over the next year based on Monday’s closing price of $24.58 – an excellent return.

Regardless of whether it hits the target or not, the analyst community’s consensus is clear: The disconnect between the stock price and the corporation’s underlying assets is vast.

In addition to appearing inexpensive and the disconnect between the share price and the average 12-month analyst estimates, Pan American has excellent assets with tremendous expansion potential. When we purchased Yamana Gold, a significant portion of the thesis rested on the growth profile tied up in a variety of Latin American mining projects, including Jacobina in Brazil, Cerro Moro in Argentina and Minera Florida in Chile. Now that Pan American owns these assets, the benefits of this growth rest with it.

Pan American is an enterprise to watch if precious metals prices remain high or rally further, especially if the company can keep a lid on costs. If it can control costs and capitalize on its growth potential, its stock price should outperform the underlying commodity.