Gold miners post record earnings and the market still isn't rewarding them

Gold miners are breaking cash flow records yet still trade as if the metal were worth half as much

There's a paradox that has held for over a year and a half: gold and silver miners are posting quarter after quarter of record results, with margins that in some cases exceed 90%, and the market still views them with the same distrust as in 2015. The metal has risen from the lows of that era, companies have paid down debt, cut costs and cleaned up their balance sheets. And yet, the ratio between the gold price and the producers' share prices remains far below what was seen in the 2000-2010 decade. The thesis behind these analyses is simple: either the market is right and something is broken, or there is a window of value that won't last forever.

What a royalty company is and why it behaves differently

Within the sector there is a model that breaks the logic of the pure producer: royalty and streaming companies. They don't extract ore. They lend money to miners to develop, build or expand projects and get paid in kind: a fixed percentage of production or an agreed amount below the market price. Their cash margins are far higher than those of a conventional mine —according to the debate, in the latest quarterly presentation one of the big ones reported cash margins of 96%, and another came in around 86%— because they are insulated from operating costs and need very little staff.

The second advantage is optionality. A royalty on a piece of land is collected on everything extracted from it, including discoveries made after the agreement. The classic example: a royalty paid in 1983 for two million dollars on land in Nevada that has produced more than 40 million ounces. The buyer didn't pay a cent more for the rest.

That explains why they trade at a multiple premium versus producers. Many see them as always expensive because of their high P/E or EV/CF. The counterargument: the premium is logical given those margins and that resilience. The key is to buy them during corrections in this volatile sector or when a one-off setback triggers an overreaction, as peine with the closure of a mine in Panama or a tax dispute at one of the big players.

The numbers behind the leverage thesis

The three largest by market cap are Wheaton Precious Metals, Franco-Nevada and Royal Gold. In terms of gold equivalent ounces, all three "produce" like a tier-one mine. Franco-Nevada reported 132,400 gold equivalent ounces sold in the second quarter, up 18% year on year, with revenue of 581 million dollars (+57%) and cash flow of 483 million (+12%). Wheaton moved 202,229 gold equivalent ounces in the quarter, up 6.3%.

On the producers' side, the comparison hurts. Agnico Eagle, arguably the best-run company in the sector, has an all-in sustaining cost of $1,459 per ounce. The GDX index average is around 1,800. With gold at around $4,700, margins are staggering. And yet, the miners peaked in March, not at the metal's high, and in August they have started to outperform gold. That detail —miners rising while the metal stalls— is what some read as the first sign that the promised leverage is starting to show up.

The gap between gold and its miners

The chart comparing the miners' index with the gold price shows a ten-year base and an undervaluation that, according to this analysis, does not match current fundamentals. The thesis doesn't require gold to reach $10,000. It's enough for the market to accept that a miner with growing margins and a clean balance sheet deserves the multiple it had in the previous cycle. If that happens, the path is to double or triple the relative valuation.

Some disagree with the timeline. Mining euphoria can take longer than an investor's patience lasts, and along the way come corrections that cut to the bone, like the one early this year. The common-sense answer to that: better to put money into businesses that work on their own than to wait for the party to arrive. The multibaggers, when they come, come on their own.

The map of names: from the big to the small

Among the producers, the review turns up names with a thesis of their own. Equinox has improved with the acquisitions of Marathon and Orla to become a producer of more than one million ounces a year. Buenaventura surprises with cheap multiples, a decent dividend and a 19.58% stake in Cerro Verde, weighed down by being heavily concentrated in Peru. Fortuna, Serabi or Wesdome are small operations that the market punishes with a discount. In royalties, Royal Gold trades at an EV/CF of 16-18, more typical of a large producer than a company of its quality, with estimated growth of 30% in gold equivalent ounces through 2030.

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The question left hanging is not whether gold will rise, but how much longer the market can ignore the fact that miners are already making money like never before. When the answer comes, it will probably come too late for anyone waiting for confirmation.