After being range-bound for the better part of five-years, gold broke out to the upside last year and is up $24% so far in 2020. So far in the 21st Century, investors might be surprised to discover that gold has vastly out-performed both the S&P500 and the Barclays Index of 7-10 year Treasury bonds (see graphic below). What it means for the world’s largest gold producer – Newmont (NEM) – is a surge in free-cash-flow. What it means for NEM shareholders is larger dividends and more share buybacks. That is especially the case given COVID-19’s impact on the US economy is far from over. There is still need for more US$ currency debasement (i.e. Federal debt) to deal with the fallout of high unemployment and an economy that has several sectors on life-support.
Source: Wall Street Journal
Due to the rally in gold prices, increased gold production, and cost-cutting efforts after the merger with Goldcorp, Newmont generated almost $1 billion in FCF over the first six-months of 2020 ($1.24/share based on 803 million shares outstanding at the end of Q2):
Source: Q2 EPS Report
That’s not hard to understand considering the company produced 1.26 million ounces of gold during Q2 and achieved an averaged realized price of $1,724/oz (up $407/oz yoy). With an all-in-sustaining-cost (“AISC”) of only $1,097, the delta to the average realized price was $627/oz. Multiply that by 1.26 million ounces equates to $790 million. Q2 FCF of $388 million was almost 50% of that number.
Note in Q2 copper and silver prices were also up nicely: 17% and 3.5% respectively.
The $1.24/share in FCF over the first six months of the year dwarfs NEM’s current $0.25/share quarterly dividend. Sure, the company has bought-back a little over $2 billion in stock over the past year and a half (see Q2 EPS release, but clearly there is room for a substantial dividend boost given the high-level of FCF generation (not to mention the price of gold is currently $150+/oz higher than the average realized price in Q2). After all, Newmont management has proven itself to be shareholder friendly in this regard:
Since the close of Q2, Newmont has been trimming around the edges of its portfolio by making several small efficiency and risk mitigation related transactions:
- Selling several non-core royalty properties for ~$90 million in cash and stock in Maverix Metals.
- A 50-50 joint venture in Columbia with Agnico Eagle (AEM) on the Anza mine. “Agnico will sole fund the Joint Venture until expenditures equal Newmont’s previous investment in the Anza project (approximately $2.9 million). Thereafter the parties will continue funding on a 50-50 basis.”
- Agreement with Kirkland Lake Gold (KL) to limit liability on the Holt Royalty. For a $75 million payment to Kirkland Lake:
As a result of the Strategic Alliance Agreement and the Option, Newmont expects to remove the approximately $350 million liability for the Holt Royalty on its balance sheet at June 30, 2020 and record a gain of approximately $275 million in Net income (loss) from discontinued operations in its results for the third quarter of 2020.
What these transactions demonstrate is Newmont management continuing to exercise capital discipline (i.e. not huge cap-ex commitments), monetizing and up-grading non-core assets, and limiting future liability.
Yet the biggest tailwind for Newmont continues to be the COVID-19 impact on the economy and the resulting US currency debasement. The Trump administration was already running an annual deficit of $1 trillion prior to COVID-19, but total US Federal debt has skyrocketed in 2020 due to COVID-19 “stimulus” packages:
Source: St. Louis Federal Reserve
And while gold has been in somewhat of a holding pattern while the Trump administration and the House have been unable to come to agreement on the next stimulus package, Federal debt is going to increase one way or the other: either by a new stimulus bill (the House wants $2.2 trillion), or by unemployment benefits due to all the people who will lose their jobs in the airline/tourism and other sector, or both.
Oscar Munoz, the Chairman of United Airlines (UAL), says the industry must shrink by half to survive. “The stark reality of what we’re facing is dire.” All the ancillary business would also be affected by a serious decline in air traffic – hotels, rental cars, restaurants, etc.
As bad as 8.4% is, it could get worse as the payroll protection plan (“PPP”) expired with no replacement. CNBC reports: “As of Aug, 31, 163,735 businesses have indicated on Yelp that they have closed, a 23% increase since mid-July” and “permanent closures have reached 97,966, representing 60% of closed businesses that won’t be reopening.” Meantime, US goods trade deficit rose in August to a record $82.9 billion.
After more than 6 months into the pandemic, the US still has a high level of new COVID-19 infections (43,000+ yesterday) and community transmission and the trend appears to be rising as we head into Fall flu and holiday season:
Source: NY Times
Still, there is arguably no high-level federal plan to address COVID-19 other than to try to pull-out all the stops to accelerate vaccine development. Yet polls show that Americans are losing faith in a vaccine due to political involvement in the vaccine development process and may not take it even if/when it becomes available:
Source: Pew Research
Summary & Conclusions
The point of all this depressing economic news is that government spending is going to keep going up, while government receipts due to the slowing economy are likely to go down. That means much more US Federal debt, more US$ currency debasement, and likely higher gold prices going further. That means greater FCF for Newmont shareholders. I’m not happy to say it in the case of COVID-19, but it’s true: “One Man Gathers What Another Man Spills.”
Disclosure: I am/we are long NEM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.