Year to date, shares in Mexican gold and silver miner Fresnillo (LSE: FRES) have been the worst performer in the FTSE 100. On the back of a relentless barrage of negative news, the stock has fallen 43%. Trading at levels not seen since 2009, I believe that the stage may be set for significant price appreciation over the coming years.
Half-year results
Precipitating the 10% decline in its share price over the past week, was the release of another disappointing trading update.
Revenues for the first half of 2023, jumped 6.7%. This was due to increased gold and silver production, together with higher realised selling prices. Despite this, profits fell 37% as costs soared.
Driving 75% of the $114m increase in production costs were two factors. First, the devaluation of the Mexican Peso against the US dollar, and second, cost inflation. Virtually all parts of the business saw double-digit increase in prices, including labour, electricity, diesel and operating materials.
Gold, a superior alternative?
In my view, the case for owning precious metal mining stocks today is based on the totally unsustainable level of public debt that has been building across Western economies.
A couple of months ago, the concept of the debt ceiling hit the headlines again. Having reached its debt limit, the US government was unable to issue new treasuries (that is, securities, or debt obligations, it issues that are backed by the might of the US economy). Consequently, it was funding its day-to-day operations by drawing down its cash balance from the Treasury General Account (TGA).
Eventually, the impasse was broken, and the debt ceiling raised. Since then, the government has issued an astonishing $1trn in treasuries, in order to refill the TGA. The question though, is who’s buying up all this new debt?
One institution that certainly isn’t is the Federal Reserve. It has been shrinking its balance sheet assets, through a process called quantitative tightening.
The Treasury market is the key to the entire financial system. This point can be aptly demonstrated through what happened to the yields of UK gilts (the UK equivalent of US treasuries) following the calamitous mini budget last year.
Recently, the yield on the 10-year UK gilt has surpassed even those levels. To my mind, this position is completely unsustainable. Interest payments alone are ballooning. In such an environment, I would much prefer to own gold, a scarce monetary metal with centuries of history of holding its value.
Exploration
One key reason why I like Fresnillo over other miners is its healthy pipeline of new projects. This year marked the opening of a new mine at Juanicipio. It’s expected to contribute an additional 11.7m oz of silver and 43.5k oz of gold, yearly, over the life of the mine.
In the first half of 2023, it ramped up its exploration spend by 25%, to $97m. Of course, exploration is a risky business. However, I would much prefer to see a miner spend its cash on looking for new reserves than paying dividends to shareholders.
Fresnillo shares have a history of moving explosively in response to metal prices. Between 2009 and 2011, its stock appreciated 22 times. I believe the stage is being set for a similar move in the near future and why I intend to buy more at these depressed levels.
