[This blog post is an excerpt from a commentary published last week at www.speculative-investor.com]

Jurisdictional risk materialises with no warning

Jurisdictional risk is any additional risk that arises from doing business in a foreign country. The problem with this type of risk is that when it materialises, it does so without warning.

As exemplified by two recent events, jurisdictional risk for gold mining companies is relatively high among the countries of West Africa (the countries highlighted on the following map). The first of these events was a statement in early-October from the president of Burkina Faso that the government may withdraw existing permits for gold mines. This statement affected a number of Western gold mining companies, including TSI stock selection Fortuna Mining (FSM). FSM currently generates about 25% of its gold production in Burkina Faso.

The aforementioned statement by Burkina Faso’s president caused a 10% single-day plunge in the FSM stock price. The company put out a press release that soothed fears and the stock price quickly recovered, but the risk remains and could move back to centre-stage at any time.

The second of these events occurred early this week when Australia-listed Resolute Mining (RSG.AX), which is not a current TSI stock, advised that its CEO and two other employees had been detained by the government of Mali due to a disagreement over the government’s share of revenue from RSG’s Syama gold mine. In response to this news the RSG stock price immediately dropped by around 30% and, as illustrated by the following daily chart, is down by more than 50% from last month’s high. At the time of writing the employees are still being held hostage by the Mali government, which apparently is demanding a $160M payment.

In response to the RSG news, the stocks of some other gold mining companies with substantial exposure to Mali were hit hard. The hit to the B2Gold (BTG) stock price was relatively mild, however, even though the company’s most important currently-producing mine (Fekola) is located in Mali. We assume that this is because the company negotiated a new agreement with the Mali government only two months ago.

When nothing untoward happens in a country with high jurisdictional risk over a long period, investors tend to forget about the risk and the risk discount factored into the stock prices of companies operating in that country becomes small. As mentioned at the start of this discussion, the problem is that when this type of risk materialises, which it eventually almost always does, there is never any warning and therefore never time to get out prior to the price collapse. This is not a reason to avoid completely the stocks of companies operating in high-risk countries, but it is a reason to only buy such stocks when the risk discount is high and to manage the risk via appropriate position sizing and scaling out into strength.

Balance sheet risk materialises WITH warning

Unlike jurisdictional risk, balance sheet risk doesn’t suddenly appear out of nowhere. The signs of trouble are almost always obvious for a long period before the ‘crunch’. If management doesn’t take decisive action soon enough to recapitalise the company, there will no longer be an opportunity to recapitalise in a way that doesn’t destroy a huge amount of shareholder value. On Wednesday of this week the shareholders of i-80 Gold (IAU.TO) learned this lesson.

The IAU stock price was down 58% to a new all-time low on Wednesday 13th November in reaction to the company reporting its financial situation, operating results and a new development plan. In a nutshell, it was an acknowledgement that the company is under severe financial stress. However, this should not have come as a big surprise given that the company reported a working capital deficit of US$60M more than three months ago and has a loss-making business, meaning that the working capital deficit was bound to increase in the absence of new long-term financing.

A strong balance sheet is especially important for gold mining companies that either are in the mine construction phase or have commenced production but are not cash-flow positive. That’s because such companies need a sizable ‘cash/financing cushion’ to stay in business. For exploration-stage companies, having such a cushion is not as critical because these companies can survive by either temporarily stopping their exploration work or doing the occasional small equity financing.

The crux of the matter is that close attention should be paid to the balance sheet, which forms part of the information that public companies issue on a quarterly basis.

[This blog post is an excerpt from a commentary published at www.speculative-investor.com last week]

This is our annual reminder that gold mining stocks should always be viewed as short-term or intermediate-term trades, never as long-term investments. If you want to make a long-term investment in gold, then buy gold bullion.

The reason is illustrated by the following weekly chart. The chart shows more than 100 years of history of gold mining stocks relative to gold bullion, with gold mining stocks represented by the Barrons Gold Mining Index (BGMI) prior to 1995 and the HUI thereafter. The overarching message here is that gold mining stocks have been trending downward relative to gold bullion since 1968, that is, for 56 years and counting.

We’ve explained in the past that the multi-generational downward trend in the gold mining sector relative to gold is a function of the current monetary system and therefore almost certainly will continue for as long as the current monetary system remains in place. The crux of the matter is that as well as resulting in more mal-investment within the broad economy than the pre-1971 monetary system, the current monetary system results in more mal-investment within the gold mining sector.

The difference between the gold mining sector and most other parts of the economy is that the biggest booms in the gold mining sector (the periods when the bulk of the mal-investment occurs) generally coincide with busts in the broad economy, while the biggest busts in the gold mining sector generally coincide with booms in the broad economy. The developed world, including the US and much of Europe, entered the bust phase of the economic cycle in 2022 and the bust is not close to being over. This means that we are in the midst of a multi-year period when a boom should be underway in the gold mining sector.

To date, the gold sector’s upward trend from its 2022 low hasn’t had boom-like price action. The main reason is that the current economic bust is progressing more slowly than is typical, largely because of the efforts of the US government to boost economic activity via recession-like deficit spending and the parallel efforts of both the Treasury and the Fed to boost financial market liquidity. A related reason is that during the economic bust to date the broad stock market has performed unusually well. This has meant more competition for the attentions of speculators and investors. The gold sector has been generating good operating results and stock market performance, but so have many other sectors.

We expect that over the next 12 months the gold mining sector will continue to demonstrate strong earnings growth while most other sectors see flat or declining earnings as the economy slides into recession. This contrast should lead to boom-like price action in the gold sector. In fact, we think that the HUI could trade north of 600 next year while remaining in its long-term downward trend relative to gold bullion.