Seeing the price of gold move from $1,785/oz on January 27th up to $1,860/oz at close on February 11th is a welcome move for all (except those holding a short position). But with the move up of $75 per oz over a short two week period, it begs the question - Are there certain classes of gold companies that benefit more than others from a modest jump in the price of gold of say $100 per oz?
For this article, I am only considering active gold producers and not considering exploration, development, or royalty/streaming companies. But among producers, the first thing to point out is that for every producer, an upward move in price of ~5.5% always has an out-weighted benefit to their bottom line. The reason is that a quick move of say $100 per oz normally has negligible impact on the production costs of the company. So the extra $100 per oz from sales all goes to improving the bottom line. So, if a producer has a project with an AISC of $900/oz, the increase in the price of gold of 5.5% actually increases the profitability of their operation by 11%. Instead of earning a gross margin of $900 per oz of gold produced, the gold producer would make $1,000 per oz (11% increase per oz). While I would never try to dissuade someone from holding gold or silver in their portfolio, the reality is that, in terms of impact on earnings, which we should expect to have a somewhat similar impact on share price, owning an active gold producer provides an opportunity to increase the rate of investment return over the rise in the commodity itself.
But returning to the original question, are there certain classes of gold producers who might disproportionately benefit from an increase in the price of gold? Funny enough, just looking at the basic arithmetic, the higher the cost of a gold producer the more that they benefit from the increase in gold price. This is a bit counterintuitive - the less efficient a company is with its gold production costs, the more they can expect to benefit from an upward move in commodity price.
To illustrate this point, let's look at a hypothetical comparison of how a $100/oz increase would have impacted the third quarter performance of two companies: McEwen Mining ($MUX) and Kirkland Lake (now a part of $AEM).
McEwen Mining: McEwen has certainly had its struggles of late on multiple levels. While the company has made substantial improvements of late increasing production and lowering costs, McEwen has had its struggles across its operations including some unforced errors. In 3Q21, McEwen produced gold equivalent ounces of approximately 31,500 oz (factoring in its partial ownership of the San José Mine). The All-In Sustaining Cost (AISC) across its projects was approximately $1,514. But, if we examine the impact of an increase in price from $1,800 to $1,900 would've had on their 3Q numbers, we are looking at a per oz profit margin increase from $286 to $386. This means that the 5.5% increase in the price of gold would have improved the production margin of McEwen Mining by almost 35%! That is almost a six-fold multiplier impact on operating margin.
Kirkland Lake: KL was a absolute juggernaut by consistently being one of the lowest cost and profitable gold producers in the world prior to its acquisition by Agnico Eagle. For 3Q21, KL had an AISC of $740 - which is beyond exceptional. Even crazier is that the AISC for Fosterville was a minuscule $337/oz! So how would an increase in the price of gold from $1,800 to $1,900 have impacted the operational margins of KL in 3Q21? Their profit margin per oz would have increased from $1,060 per oz to $1,160 per oz - or about a 9.5% increase. No question that the increase in the price of gold would have helped, but it wouldn't have provided the same boost to profit margin that someone like McEwen would expect to see.
I am not trying to argue here that a modest increase in the price of gold somehow makes a higher cost producer suddenly better than a lower cost producer as a company or even as a long-term investment holding. Instead, it stands to reason that in terms of impact on the bottom line in the near term, the higher cost producer should expect to benefit disproportionately from the increase in the price of gold in terms of their profit margin. And if we are to assume that share price has a reasonable relationship with EPS, then we would also expect the share price of these marginal producers to also be disproportionately benefited by an increase in price of gold in the near-term. As the purpose of investing is to maximize returns, it might make sense not to look at the highest quality or most profitable producers, but instead to look at the producers that would benefit the most from a move in commodity prices. Sometimes the best companies don't always provide the best returns. For this reason, because I am bullish on gold and anticipate seeing a move to the $2,000/oz range in 2022, I will be opening up a number of reasonable positions in a collection of companies that have lower production and higher costs that I classify as "marginal gold producers" in hopes that they will provide a higher investment gain opportunity (as a group) in the event that the upward movement we are seeing the price of gold continues through the next few weeks. Sometimes it makes sense to kiss some frogs and see what happens... just don't lick any toads - that doesn't work.
