With “inflation expectations” (fears) at a 40-year high, this emerging gold producer offers a stellar value proposition for a high-inflation environment
It’s official. (High) inflation is no longer
“transitory”. And as anyone who shops for
food and many other consumption staples already knows, it’s
much worse than the dubious “official” numbers.
With supply chains breaking down and war and pandemic exacerbating price pressures further, many astute commentators see inflation getting
considerably worse before it ever starts receding.
This begs an obvious question for wary investors. Where can we find shelter from this inflation?
A better question: where can we find the
best shelter?
The short answer is emerging gold producer,
Minera Alamos (CAN:MAI / US:MAIFF). The long answer to that question requires considerably more explanation.
Gold: the ultimate inflation hedge
Inflation has only recently become a concern to most people. That’s a shame.
This monetary disease eats away at the purchasing power of our paper currencies, every minute of every day. All that varies is the speed with which inflation consumes our wealth.
However, there is an antidote to this monetary disease: gold and (to a lesser extent) silver. A historical example will illustrate this nicely.
Over roughly the last 100 years, the price of residential real estate in Manhattan has
increased by approximately 10,000%, expressed in U.S. dollars. Flipped around, with respect to buying residential real estate in Manhattan, the purchasing power of the U.S. dollar has decreased by >99% over this time period.
Then there is gold.
Over that same 100-year interval, priced in gold, residential real estate in Manhattan has only increased by 25%. The 10,000% increase in price (in U.S. dollars) versus the 25% increase priced in gold is almost all inflation.
Gold-holders have been immune to that inflation, 100 years of it. Meanwhile, U.S. dollar-holders have seen 99% of their purchasing power evaporate. And today inflation is really heating up.
Note that there are significant costs to holding real estate: property taxes as well as maintenance. In contrast, the cost of holding gold is near-zero. Over 100 years, minus holding costs, gold has significantly outperformed Manhattan residential real estate.
Over the past century,
not only has gold been a perfect shield against inflation, it has been a better investment than Manhattan residential real estate.
Gold carries no counterparty risk and (unlike real estate) is portable.
This historical perspective should make it easy to see why gold is viewed by most sophisticated investors as the ultimate Safe Haven asset.
Obviously, every prudent investor should devote a significant percentage of their investment portfolio to gold even in the best of times. In the worst of times – like today – many investors will want to insure a much greater percentage of their wealth with this Safe Haven.
In an environment of rising inflation (and a rising gold price), is there a way to
leverage this asset class? Yes.
Gold mining companies leverage the price of gold
Dynamic Wealth Research has
explained to our audience in the past how/why gold mining companies provide natural leverage to a rising price of gold (and similar leverage when the price is falling).
Expressed succinctly, as a proposition of simple arithmetic the profit margins of gold mining will always rise at a much faster rate than the price of gold.
Depending on the cost structure of a particular mine, a 10% rise in the price of gold could as much as
double the profitability of that gold mine. In turn, that doubling of profitability should generate much more than a mere 10% increase in share price for investors.
Natural leverage.
For gold investors looking to get the most bang for their buck, the gold mining companies themselves offer the maximum potential return. Even for a mature gold producer, gold mining companies will deliver this leverage with a rising gold price.
However, that’s not where most experienced mining investors park most of their investing dollars. Senior gold producers have been notorious underperformers in any/every bull market for gold.
Gold mining investors looking to maximize portfolio performance will focus their investing on junior mining companies and select intermediate and mid-tier producers with strong growth profiles.
The junior producers offer something that the senior producers can’t deliver: significant production growth. While many senior producers struggle just to maintain their gold production, the stronger juniors can deliver multiples of their original gold production.
In turn, the gold mining companies that deliver the optimal amount of growth potential are the emerging producers. Junior mining companies moving from zero gold production to whatever plateau their management team is able to achieve.
Here many savvy investors will already be connecting the dots.
Gold is the best hedge against inflation. Gold mining companies naturally leverage gains in the price of gold. Emerging gold producers offer the maximum growth potential among gold mining companies.
Conclusion: the ultimate investing hedge in a high-inflation environment is an emerging gold producer. Yes, but with a very important caveat.
While gold may be “immune” to inflation, gold mining companies themselves are not. In particular, gold mining companies seeking to expand production via building new mines face a very real inflation risk: soaring mine construction costs.
Inflation in mine construction costs is “a mining cost crisis”
Throughout the world of business, input costs are skyrocketing, from labour right through to most raw materials. That translates into radically increasing construction costs for almost anything. And a mine is no exception.
The headline from this February 2022 article is self-explanatory. While “high inflation” is everywhere, one place where rising price pressures are being felt the most is in the construction of large capital projects – such as a mine.
Large construction projects require vast amounts of labour and enormous quantities of an assortment of raw materials. Inflation flowing
upward, in the form of rising commodity prices and wages, means that such projects reflect some of the highest inflation levels.
Bardoc Gold (ASX: BDC) was an early example of the cost crisis in WA, one of Australia’s premier mining regions, where closed borders and an acute shortage of skilled labour has created a hothouse economic environment which is bruising all industries.
Like Geopacific, Bardoc was confident of being able to develop its namesake mine near Kalgoorlie, until late September when costs killed that plan.
In March last year, the pre-production capital cost of the Bardoc mine was estimated, in a definitive feasibility study, to be $177 million.
Six months later, after a strategic review, the pre-production capital cost had blown out by 31% to $232 million.
A cost increase of 31% over 6 months translates into an annual “inflation rate” of well over 60% for mine construction. Obviously, precise economics will vary from project to project, but this example provides a good ballpark figure of cost increases in mine construction today.
In turn, such skyrocketing costs can ruin the economics of some gold projects, even with a rising price of gold. And that translates into significant investor risk for most “emerging gold producers”.
Does this mean that investors need to be more conservative with their investing and focus on only established producers? Not necessarily.
Enter Minera Alamos.
In the gold mining industry (or any mining, for that matter) what is the antidote to soaring construction costs when it comes to developing a mining project? Answer: being able to put a project into production
fast and cheap.
As outlined in a recent Dynamic Wealth Research feature, Minera Alamos’ first gold mine, the Santana Mine is now ramping up to commercial production, expected to reach an annual output of ~50,000 ounces of gold per year.
Thanks to the Covid pandemic, Santana wasn’t put into production as quickly as it would have been otherwise, but it was certainly cheap. Total costs to put Santana into production are around
USD$10 million.
[Some of the first gold dore production from the Santana Mine]
Dynamic Wealth Research reached out to the
President of Minera Alamos,
Doug Ramshaw, to encapsulate the Company’s strategy for building and operating gold mines.
“Minera focuses on a three pronged approach to our mine builds and for us to proceed the project in question must meet all three criteria. Simply put, is there enough gold initially outlined to make for a profitable operation? If we proceed with that build, can it be done quickly and cheaply? And, finally and most importantly, can we see a path to growing that starter operation into something larger funded from the early operational cashflows?
Our operations team has a passion for building mines and have done so successfully on numerous occasions but what I love about how they operate is they find these elegant ways to cut costs, not corners, and in doing so provide an efficient path to establishing the foundation of our gold production profile from which to grow.”
To put this into perspective, the profits from the 14,000 ounces of gold
already mined at Santana as management begins to ramp up production should pay for the entire costs of mine construction. That’s an “IRR” that will put a smile on the face of most investors.
Coming soon will be Minera Alamos’ second mine, the Cerro de Oro Project. A final decision on production for Cerro is expected at the beginning of 2023. After that, management estimates that
mine construction can be completed in 6 – 7 months, which could lead to first gold production before the end of 2023.
Construction costs at Cerro will be somewhat higher than Santana, with management offering
a ballpark estimate of USD$25 million.
Part of those higher costs reflect the soaring inflation previously referenced. Part of the higher price tag reflects the expectation that Cerro will be a significantly larger producer: an estimated 60,000+ ounces of gold per year to begin with growth beyond that.
Between now and the commencement of construction, what happens if costs to put Cerro into production should leap by 31%?
Then it would cost approximately USD$35 million to put the mine into production. At Cerro de Oro’s expected full rate of production, those extra costs could be recouped from the revenues of ~3 weeks of mining operations.
This is the beauty of the low capital intensity of Minera’s gold mines. In the context of high inflation, such “beauty” equals reduced investor risk.
By the time that Santana and Cerro de Oro are both in full production, Minera Alamos will be a 100,000+ ounce per year gold producer, built off of a near-zero risk operational strategy. At current gold prices,
revenues from the two mines will likely exceed USD$200 million.
Plug that cash-flow into the Minera Alamos low-cost model for gold mine development and where does it lead?
In the eyes of President Doug Ramshaw and the Minera team, it leads to intermediate gold producer status over the medium term: 250,000 ounces per year. Beyond that, it’s a foundation of growth and gold production that could eventually take Minera to mid-tier status.
Next in line for production after Cerro de Oro is Minera Alamos’ 3rd project, La Fortuna. Another low-cost/open pit mining operation, but this one with much
higher grades, an average of 3.5 – 4g Au equivalent (including silver/copper credits). Even more upside potential, same low-risk model.
Unlike gold, Minera Alamos isn’t immune to inflation. But stacked up against its mining peers, it’s pretty close.
Unlike gold, Minera Alamos can/will leverage the rising price of gold.
Gold is the ultimate Safe Haven asset and an important component in any investor’s portfolio. However, the best hedge against inflation today is arguably an emerging gold producer with a fast/efficient low-cost production model:
Minera Alamos.
DISCLOSURE: The writer holds shares in Minera Alamos.
