Druckenmiller's gold miner bet
Estimated reading time: 25 mins
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Summary
Stan Druckenmiller just bought shares in Barrick Gold and Newmont Mining.
He thinks gold serves as a store of value, but only over the long run. It’s a hedge against any devaluation of the US Dollar. He also seems to think that gold prices should go up in a scenario of lower interest rates, higher inflation rates or a combination of both.
His outlook for 2024 is that central banks in autocratic countries like China and Russia will likely continue buying gold. Meanwhile, interest rates are likely to come down. Also, Donald Trump will likely move towards easier monetary and fiscal policy if and when he becomes President in November 2024.
Investors can get exposure to gold through gold bullion, ETFs, futures and gold miners. But gold miners have underperformed the gold price historically, probably because it’s a commodity industry with management teams trying to gain at the expense of minority shareholders shareholders.
Towards the end of the post, I go through the listed universe of Australian gold miners and discuss what stocks might offer value as of March 2024.
Famed investor Stan Druckenmiller just sold some of his US tech stocks and bought gold miners Barrick Gold and Newmont Mining instead. Why?
In this post, I’ll discuss how Druckenmiller has historically viewed gold, whether gold actually serves as an inflation hedge and why he might have invested in gold miners now.
Towards the end, I’ll then discuss the gold mining industry and dig into the Australian gold miners that belong to my investment universe and that I personally pay close attention to.
Table of contents
1. Stan Druckenmiller’s view on gold
3. How do you value a shiny rock?
4. The gold price in 2024
5. Ways to gain exposure to gold
6. A hole in the ground with a liar on top
7. The investable universe of Aussie gold miners
8. Conclusion1. Stan Druckenmiller’s view on gold
Druckenmiller rarely talks publicly about his views on gold. So, we’re forced to infer his views from past discussions. I’ve gone through a dozen or so interviews to understand how he thinks about the metal.
The first discussion I found was his September 2013 interview on CNBC, where he said he traded gold based on his views of whether the Fed would continue with its quantitative easing program (printing money and buying Treasury bonds from financial institutions):
“You’ve got to love gold here. When you look at a potential Yellen Fed and the inability to instigate any serious tapering unless there’s something extraordinary going on… [in a scenario of tapering] gold would have gone down to US$1,200/ounce.”
At the Sohn Conference in May in 2016, he said that gold “remains our largest currency allocation” due to the Federal Reserve’s easy monetary policy. Though after Donald Trump got elected in November 2016, he sold all his gold and short bonds globally, thinking that interest rates were going to head higher.
In May 2021, in a conversation with Toggle AI, Druckenmiller said that he views gold as a liquid store of value:
“I’ve always looked at gold as a store of value, as I don’t trust fiat currencies. Paul told me that the fact that Bitcoin had been around 13 years hade made it into a brand. I tried to buy a US$100 million at 6,200 and it took me two weeks… I said this is ridiculous that it takes me two weeks, I can buy that much gold in two seconds.”
But it’s hard to know exactly what gold might be worth. In a December 2017 interview with CNBC, Druckenmiller said that gold is worth exactly what people are willing to pay - that its value is hard to pinpoint:
“Bitcoin is like anything else, it’s what people are willing to pay for it… let’s say they’re willing to pay 17,000 - that’s what it’s worth. The tulips were worth when people were paying that for them. Gold is what it’s worth.”
In Druckenmiller’s 2021 interview with Bowdoin College, he said he expected the stimulus to create inflation, which might not help gold but should help commodity-oriented companies:
“If inflation goes up, you don’t want to own bonds, you don’t want to own equities… you may not want to own gold because the interest rates will go up and gold trades off interest rates…. but there will be things you can own, certainly commodity oriented companies and real commodities. Inflation will just be very difficult.”
Further, in April 2023, in a talk with Nicolai Tangen at Norges Bank he suggested that he’s betting on gold as a way to be on the devaluation of the US Dollar:
“The only space I have any risk right now is the US Dollar, and I’m obviously long gold for the same reasons.”
In a conversation with Kiril Sokoloff in May 2023, Druckenmiller said he believed that the Russia-Iran-China camp of countries is shifting out of US Dollars into gold:
“We own gold and silver right now. They historically have not done well in hard landings, but given that monetary and the fiscal authorities are kind of at the end of their rope. And given the fact that other countries have decided particularly autocracies not to hold their reserves in dollars, I'm betting for the time being against the history of the performance of gold in hard landings.”
At his October 2023 chat with Paul Tudor Jones at the Robin Hood conference, Druckenmiller said he viewed gold as a store of value with a 5,000-year brand:
I’m surprised that Bitcoin got going. But it’s clear that young people see Bitcoin as a store of value because it’s easier to do stuff with. And 17 years, to me, it’s a brand. I like gold because it’s a 5,000 year brand, but the young people have all the money… so I like them both.”
And in the same interview, he stated that he expects inflation to flare up if and when Trump gets elected:
“We’ve got from US$800 million in the Fed balance sheet to US$9 trillion, and if Donald Trump’s elected, trust me, it’s going to up a lot more in the next term… Trump is a big spender. He doesn’t believe in the Federal Reserves. And we go back to the Arthur Burns model times two. We have fiscal recklessness without abandon, just like he runs his business. And on top of that, he puts a puppet in the Federal Reserve. Under that model, you have to be open-minded to 8-10% inflation rate take-off like it did in the 1970s”
So, to summarize, Druckenmiller sees gold as a store of value with a strong investor “mindshare” thanks to its 5,000-year history. It’s hard to know exactly what gold should be worth, but over time, it should benefit from a devaluation of the US Dollar against hard assets. And it should go up if interest rates come down or inflation increases more than expected.
But let’s think a bit deeper about how to think about gold — whether it’s at all possible to have a view on the price of a piece of rock.
2. How do you value a shiny rock?
The mining industry is often sorted into the three categories of bulk commodities, base metals and precious metals, of which gold is perhaps the most prominent:
Bulk commodities are bulky and include coal and iron ore. Base metals oxidize, and such metals include nickel, aluminium, copper, etc. Precious metals do not belong in either of these categories. Those include gold, silver, platinum, palladium and rhodium.
What makes precious metals unique is that they’re scarce and have little utility, other than perhaps as ornaments. Some of them do have industrial applications; for example, silver is used in batteries and platinum in catalytic converters.
But for most purposes, precious metals are status symbols first and commodities second. The following table shows just how special gold is as a commodity. The average ore grade is so low that the price per unit of weight is higher than for any other commodity. The high price might explain why it’s not used for much other than a status symbol or a store of value.
Druckenmiller argued that gold is worth exactly what people are willing to pay for it. And indeed, it’s hard to argue that gold has any “intrinsic value”, per se. But gold does have a few properties that make it special:
It does not depreciate
It’s resistant to corrosion
It’s easily divisible
It’s a scarce resource
The fact that gold does not depreciate means that every ounce that has been mined still exists somewhere on the earth's surface. Total above-ground stocks are now over 200,000 tons. From that perspective, a yearly mined supply of 5,000 tons is minuscule since it means that the supply only grows about 2.5% per year.
So even if there is a small mismatch between the supply & demand for gold in a given year, it won’t necessarily affect the gold price. Instead, what matters for the gold price is what the owners of the current stock of 200,000 tons do.
Most of these owners consider gold as a store of value or a currency that keeps pace with inflation. And it has kept pace with inflation, at least over the very long-run.
Here is a chart of the gold price measured in US Dollars:
Until 1933, the price of gold was fixed at US$20/ounce, then US$35. In 1971, the US Dollar went off the gold standard and gold then became a floating asset. And since 1971, gold prices have moved sharply upwards at a compound annual growth rate of +7.8%.
This performance does not mean that gold has become more valuable. It just reflects. a devaluation of the US Dollar measured in gold terms. The following chart from Robert Shiller shows that gold has protected capital from inflation quite well since the US went off the gold standard in 1971 - almost matching the performance of the S&P 500:
Another way to visualize gold’s ability to hedge against currency devaluation is to plot the price against the broad money supply. If too much money is being created, some of that money is bound to boost the price of gold. The following chart comes from Edmund Simms at the Valuabl Substack, which I highly recommend. It shows that the per ounce gold price tends to mean-revert to around to around 1/10 billionth of the M2 money supply, measured in US Dollars. That would suggest a fair gold price just north of US$2,000/ounce.
But who knows what price gold bugs might be willing to pay? The fact is that, while the price of gold does tend to trend upwards, its performance has also been marked by multi-decade bull and bear markets.
A more precise model has been offered by economist Paul Krugman, who argues that the value of gold is directly related to real (inflation-adjusted) interest rates. In other words, he thinks that if real interest rates go down, then gold should go up, all else equal.
Let’s say that the yearly rate of inflation is 5% per year. We should then expect the gold price to rise 5% per year as well since it does serve as an inflation hedge.
But if interest rates on US Dollar assets go up to 10%, then investors will sell gold and swap it for dollars to earn that 10% interest. Conversely, if interest rates drop to 0%, then investors will probably shun such US Dollar assets and buy gold instead for a 5% yearly return.
In other words, when real (inflation-adjusted) interest rates are high at say +5%, investors will sell down gold to earn the high interest. And when real (inflation-adjusted) interest rates drop to -5%, investors will react by bidding up the price of gold.
Empirical data supports this line of thinking. The following chart from the World Gold Council shows a tight correlation between the real gold price and real 10-year interest rates, as measured by the yield of 10-year Treasury Inflation-Protected Securities (TIPS):
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Asset manager PIMCO has found that historically, a 1.0% increase in 10-year real yields led to a 22% decline in the inflation-adjusted price of gold. In other words, gold can be seen as a super-long Treasury bond with a 22-year real duration. That’s probably why Druckenmiller sold gold together with bonds when Trump got elected in November 2016.
Another short-term model of the gold price is that offered by the “DXY” US Dollar Index, a trade-weighted exchange rate against six other major currencies. The correlation between the gold price and this index tends to be very tight in the short run. So, just like Druckenmiller alluded to, if you’re bearish about the US Dollar, by consequence, you should also be bullish on gold.
Analysts at Bernstein have found that, in addition to being a hedge against currency devaluation and movements in real interest rates, gold also serves as a safe asset during periods of significant volatility. It certainly performs better than stocks in these scenarios.
So, to summarize, gold does not trade as a commodity. Supply & demand analysis tends to be futile. Instead, one should think of gold as a currency that offers no yield but tends to protect against inflation over the very long-run. But in the medium term, it should be seen as a bet on either lower interest rates, higher inflation or a combination of both. It will also serve as a diversifier and hedge in periods of extreme volatility and fluctuate in line with the US Dollar index.
4. The gold price in 2024
The divergence between the gold price and real interest rates since 2022 came as a surprise to market participants, including myself:
With US interest rates having risen sharply since early 2022, one would have thought that gold prices should correct downwards as owners sold gold to enjoy the higher interest rates offered in the US Treasury market.
But the past few years have been peculiar. For example, the stimulus-driven expansion in the US money supply was the largest since the Great Depression in the early 1930s. And Edmund’s model of plotting the gold price against the broad money supply suggests that gold has actually become cheaper rather than more expensive.
Looking at the major buyers of the metal, you can see that central banks have ramped up their purchases since 2022:
This is a break from the past. The catalyst seems to have been Russia’s invasion of Ukraine, which led to US sanctions on Russian entities. Since then, countries with ties to the Russia-Iran-China bloc have accumulated gold rapidly to reduce their reliance on the US Dollar. China is now leading efforts to develop alternative trade systems and payment systems, with gold serving as the system’s reserve currency. Asian central banks made most of those purchases, and gold is clearly moving from the West to the East.
Looking forward, all eyes are now on US monetary and fiscal policy. The most recent Fed Dot plot suggests the Fed Funds rate will drop to 2.5% over the long run. And lower interest rates should lead to a higher gold price, all else equal.
It’s also the case that recent 3- and 6-month annualized core inflation rate has remained around the 2% mark, close to the Fed’s target. Once shelter costs drop in the next eight months, reported year-on-year CPI is likely to drop significantly. Interest rate cuts seem to be in the cards.
In addition, prediction markets such as Polymarket and PredictIt have Donald Trump winning the US presidential election in November 2024, and he’s known to be fiscally irresponsible. So we might end up with a scenario of lower interest rates in 2024 coupled with greater fiscal deficits through 2025, which should be bearish for the US Dollar and bullish for the gold price.
It’s also plausible that the demand for gold through ETFs will one day pick up again after three years of outflows. Retail investors are known to be momentum chasers, so once momentum picks up again, ETFs could become net buyers yet again.
5. Ways to gain exposure to gold
There are three main ways to gain exposure to gold: bullion, gold ETFs and gold futures. I’ll now discuss these options one by one.
5.1. Gold bullion
Historically, the most popular way to get access to gold was to buy physical gold bullion, i.e. gold bars or gold coins.
As long as you buy from reputable dealers such as APMEX, JM Bullion, or Wholesale Coins Direct, you’ll end up buying the real product. You can also buy gold bullion from pawn shops or from banks. But at the local banks where I live, I’m finding that gold bullion costs 3-5% more than what you’d pay in the wholesale markets. So just be aware of the costs.
Other problems with gold bullion are the storage cost and the security risk. From my understanding, storage at a third party facility can cost roughly 0.5% per year. If you store the bullion at home, there a risk of theft and insurance is costly.
There’s also the risk of expropriation. In the 1940s, for example, the Nazi government looted gold from individuals and the banks in the countries it occupied. The same was true of China during the Kuomintang government in the 1930s and 1940s when it forced holders of precious metals to exchange them for fiat currency.
As I’ve argued in this post, you’ll want to store your gold in a safe jurisdiction, protected by geography, a rule of law and a strong national defense. Such countries have historically included the United States, New Zealand, the United Kingdom and Switzerland.
5.2. Gold ETFs
A more straightforward way to gain exposure to the gold price is to buy a gold ETF. These tend to be liquid and have low expense ratios. They are issued by specific counterparties, so the counterparty risk cannot be ignored.
While the ETFs represent fractional ownership of the total gold held by each vehicle, you also cannot redeem them for gold. Only authorized participants (large banks) are able to create or redeem ETF units. They are the ones who ensure that the price does not deviate materially from the spot gold price.
If you compare the most popular gold ETFs, the biggest differences are in their assets under management, their expense ratios, and the bid-ask spreads for each. Here is an overview of some of the most popular options:
Which one investors prefer will depend on their objectives. For example, the SPDR Gold Shares (GLD US) have a high expense ratio but a very tight bid-ask spread and great liquidity. It’s therefore suitable for large buyers who want temporary exposure but are not looking to become long-term holders.
Conversely, the SPDR Gold MiniShares (GLDM US) is has a low expense ratio but is less liquid and has a high bid-ask spread. It’s therefore suitable for smaller buyers who are looking to hold the ETFs through multi-year periods.
In any case, the 1-year total return for each of these ETFs does not differ materially. They’ve been successful in tracking gold prices closely, save for a few basis points here or there.
5.3. Futures
Gold futures or forwards are typically used by either gold producers themselves or financial institutions. For example, if a producer wants to lock in a future price, it can sell forwards and then gain from the difference between that price and the spot price at expiry.
Since futures are driven by investor expectations, they offer a way to be on shifts in expectations about future gold prices. The current futures curve is in contango, suggesting that spot prices will rise +18.1% in the next five years, or +3.4% per year. This contango might reflect storage costs and inflation expectations.
Futures trading allows for greater leverage and the risks of margin calls. Futures are settled daily, and any loss below the maintenance margin needs to be dealt with through additional deposits, or you’ll face a margin call.
There are also funds that offer exposure to the gold futures markets, including the Invesco DB Precious Metals Fund (DBP US), which tracks the DBIQ Optimum Yield Precious Metals Index. This fund has 80% of its holdings in gold futures and the rest in silver futures.
6. A hole in the ground with a liar on top
Which takes us to the next topic. Another, more indirect way to gain exposure to the gold price is to buy a gold miner - companies that dig the metal out of the ground and sell it onto world markets.
You can view gold miners as super-charged bets on the gold price, at least in the short-run. If gold prices move up, then operating leverage will make sure that their profits will rise even more rapidly. Some of them also offer yearly dividends, which income-oriented investors might appreciate.
Others are more skeptical. Mark Twain joked that a gold miner is “a hole in the ground with a liar standing at the top of the hole”.
The historical performance of gold miners seems to support his view. For example, the VanEck Vectors Gold Miners ETF (GDX US) and the VanEck Junior Gold Miners ETF (GDXJ US) have both underperformed gold by a significant margin since 2008:
I think the reality is that mines are depleting assets, and exploration has a low probability of success. Gold mines are also overseen by management teams who are incentivized to keep the business alive for as long as possible so as to continue their compensation annuities.
The process of mining for gold is straightforward:
Prospecting: The first step is to search for new gold deposits. Geologists take surveys and lab samples to estimate potential ore grades, i.e. how much gold there is per unit volume and how easy it is to get out of the ground. Soft soil tends to be easier to deal with than hard rock. And open pit mines are simpler than underground mines.
Mining: The next step is to extract the gold from the ore surrounding it:
Near-surface deposits can be mined through open-pit mining. Companies will drill holes, fill those holes with explosives and then rocks are hauled off for refining.
Underground mines are increasingly found deep in the earth. Miners will then drill access shafts, and all along the shaft, dig vertical pits in which they put explosives to get the rocks to fall to the bottom and then haul them off to the surface.
Refining: In the final step, rocks are crunched down into fine dust and mixed with water to create a slurry. Cyanide and oxygen are added to the slurry to extract the gold. Finally, a chemical mixture called flux is used to extract the remaining non-gold components in a 1,200-degree Celsius oven, which is then used to smelt the gold into gold bars.
The accounts of gold miners are straightforward as well:
Revenues are simply a function of volumes times the gold price.
Operating costs are made up of day-to-day costs such as wages, consumable materials such as chemicals and explosives, transportation costs and power.
Other costs include taxes, government royalties, land leasing costs and project-related interest costs, which are not always expensed.
But the most important cost for miners is capital costs, which include the cost of drilling, geological- and feasibility studies, mine construction, mining equipment, and infrastructure costs such as water, power supply, roads and towns to house workers. Companies differ in how aggressive they are in capitalizing exploration costs.
In the industry, miners often refer to cash costs as the variable marginal costs incurred when mining another ounce of gold. But cash costs only include labour, fuel, consumables such as tyres and explosives, maintenance, royalties and refining costs. They do not include capital expenditures and exploration and development. It’s therefore an insufficient measure of the true cost of taking exploring for an ounce of gold.
When looking at miners, analysts pay attention to the following factors:
The amount of reserves (high confidence that they’ll be economically recoverable), measured & indicated resources (medium confidence) and inferred resources (low confidence) in millions of ounces.
The ore grade, a proxy of the abundance of gold below ground and the likely cost of extracting it.
The all-in sustaining cost (“AISC”), measuring the cost of keeping their operations running, measured in US Dollar per ounce of gold, which will tell you something about the margin at which gold can be extracted.
Source: Bank of America The jurisdiction, hinting at the risk of expropriation, tax rates, potential currency movements that might determine the cost structure and whether the infrastructure is in place to refine it and transport it out.
Capital allocation, including the track record when it comes to acquisitions and the return from prior capex, is best measured through return on capital metrics.
The progress that new projects have made from their initial geological studies, feasibility studies, government permits, etc., to actual production.
For junior gold miners - that is, early-stage mining companies that have yet to reach full production - the major factor is the likelihood of getting projections to completion.
Investors will have the so-called Lassonde curve at the back of their minds when investing in junior miners. This curve illustrates the journey a junior miner might go through as it progresses through the various stages of development, from exploration to production. Stock prices often jump when a new discovery is made, drop when capital to construct the actual mine and again jump as the mine nears completion.
7. Investable universe of Australian gold miners
Gold mining in Australia took off with the discovery of gold in New South Wales in 1851 and later in Victoria and Western Australia. The gold rush created waves of immigration from the United Kingdom and other parts of the empire to Australia.
The US Geological Survey estimates that Australia has the largest gold reserves in the world, though it only contributes to 10% of global production at around 330 tonnes per year. While the Victorian goldfields were depleted by the end of the 19th century, Western Australia continues to be a major centre for gold mining, contributing to roughly 70% of Australia’s current production.
The major gold districts can be found in the Yilgarn and Pilbara cratons in Western Australia and in the Paterson region in New South Wales:
Some of the largest current gold mines include Newmont’s Boddington and Cadia mines, Anglo American’s Tropicana mine, and BHP’s Prominent Hill and Olympic Dam mines.
Western Australian production of gold boomed in the 1990s and fell throughout the 2000s until the Boddington gold mine came into production in 2009.
You can divide Australia’s gold miners into senior producers, which enjoy scale and operate mines already in production, and junior gold miners which are smaller and often still in the exploration and development stage.
After Newcrest was acquired by Newmont Mining last year, today, I think there are three companies that can be viewed as senior producers:
Northern Star Resources (NST AU - US$10 billion) owns three gold mines in Kalgoorlie in Western Australia, in Yandal in Northern Territory and in Pogo in Alaska. It’s grown through a number of transformative acquisitions, including the Paulsens Gold Mine in 2010 and the merger with Saracen Mineral for AU$5.8 billion in 2020. From what I can tell, the acquisition was made at a decent transaction multiple, thus being accretive to Northern Star shareholders.
Evolution Mining (EVN AU - US$4.0 billion) operates across Australia and Canada at the Mungari mine close to Kalgoorlie, Cowal in New South Wales, two finds in Queensland and in Red Lake Ontario, Canada. It’s supposedly among the lowest-cost producers globally in terms of all in sustaining cost (AISC). Founded in 2011 by a man called Jake Klein who remains the Executive Chairman, who grew the company through several large acquisitions.
Regis Resources (RRL AU - US$944 million) is a smaller miner but still mature enough to be considered a senior producer thanks to its high-quality assets. It owns the Duketon gold project and a 30% stake in the massive Tropicana Gold mine in Western Australia, along with smaller developments at McPhillamys in New South Wales. It does not have a strong controlling shareholder anymore.
The valuation of these companies measured in EV/Resources is fairly similar, suggesting that the market values them in a similar fashion. The EV/EBITDA ranges from 4.6x for Regis Resources to 5.2x for Evolution Mining and 6.8x for Northern Star Resources. In terms of return on equity, Northern Star scores highest at 8.9% but this number will fluctuate through the cycle.
The junior miners tend to be more speculative and, therefore, best valued using EV/reserves rather than resources. Resolute Mining (RSG AU - US$511 million) looks cheap but partly operates in West Africa and has suffered significant share count dilution throughout the years. Calidus Resources (CAI AU - US$62 million) is ramping up production, has a decent CEO but is indebted and remains sub-scale, a challenge when it comes to paying recurring expenses. De Grey’s (DEG AU - US$1.6 billion) Mallina project is ranked by industry experts as one of the most promising anywhere in Australia, and it will go into production in 2027. West African Resources (WAF AU - US$678 million) trades the cheapest of any Australian gold miner in this sample at just US$100/MOz and has great returns on capital but operates in a tough jurisdiction, Burkina Faso. They’re currently building a second mine, which will be ready in 2025 and is estimated to produce over 200k ounces per year. The other miners in the sample seem to trade in a tighter range of around US$300 million per million ounces of reserves.
8. Conclusion
I think Druckenmiller is right that gold serves as an inflation hedge, but only over the very long run. In the short- to medium-term, he thinks gold should benefit from lower interest rates, higher inflation and a weaker US Dollar. This scenario seems plausible to me, and I’m therefore considering some gold exposure.
As for gold miners, I do think it’s a treacherous industry. Gold miners on the whole haven’t outperformed gold, so I’d have to pick them wisely. Within Australia, I do think the De Grey story makes sense, with third parties commenting that Mallina is the most promising new gold mine anywhere in Australia and is set to ramp up production by 2027. West African Resources also makes sense to me, especially when a second mine will be ramping up by 2025. I’m just wary of miners in general and will tread with caution.
Amazingly informative article, beats any reporting in the likes of WSJ and FT, thank you!
2 points: 3.4% pa for futures reflects the interest savings compared to holding the physical. Also there is a 2x geared ETF, UGL. It may underperform gold itself over the long term, but may well outperform gold and/or the miners on a one year time horizon.