In all the years I have been following the stock market, I cannot recall a time where one stock has outperformed every other constituent in the FTSE 100 by such a wide margin as Fresnillo (LSE: FRES) and yet seems to grab so few headlines. It is up 261%, while year-to-date the Rolls-Royce share price is up 92% but continues to grab most private investors’ attention.
Fresnillo on the rise
Soaring gold and silver prices have propelled the Mexican precious metals miner into the big league when it comes to free cash flow generation.
Relative to its size, when I compare the level of cash flow the company is generating, the all-conquering and all-owning Magnificent 7 stocks pale into insignificance.
But parabolic moves in precious metal prices alone do not account for the 415% increase in the stock since March 2024. After all, another major FTSE 100 miner, Endeavour Mining, has performed nowhere near as well.
I believe two major factors account for the difference. Firstly, falling production costs. Over the last few years the business has worked hard to improve the operational efficiency of its mines, and this is finally starting to bear fruit. Secondly, there’s its massive silver exposure.
Interest rates
An expected interest rate cut next week by the US Central Bank, the Federal Reserve, is the main reason why gold prices recently hit another new all-time high and silver breached $40.
In the face of a rapidly slowing US economy, and a major downward revision in US employment numbers, the US government is ratcheting up the pressure on the Fed. But to me there is more here than meets the eye.
Interest payments on public debt currently stand at 5% of gross domestic product (GDP). In other words the US economy needs to grow each year by at least that amount just to keep up the payments.
Investors are waking up
The last few times the Fed cut interest rates, the crucial 10-year treasury bond (the equivalent is the gilt in the UK) actually began to rise. The reason for this is that the bond market is becoming increasingly nervous about cutting rates when inflation is nowhere near tamed.
Should the 10-year Treasury continue to rise in the face of a Fed cutting cycle, then drastic measures could very well be required. One tool used in the past would be to cap yields on longer-duration bonds. That would be disastrous for bond holders, but would undoubtedly push gold prices even higher.
Pull back
I fully expect gold and silver prices to fall at some point, perhaps significantly. With a trailing price-to-earnings ratio of 50, there is an argument for saying that the stock has got ahead of itself. In addition, its large silver exposure is a double-edged sword. Should a recession happen, demand for the industrial metal could wane.
I believe that the unprecedented move in precious metal prices over the last year is a sign of something much bigger coming. A 15-year period of zero interest rates, and a resulting binge on debt may be coming home to roost.
Should the US fall into a recession, the Fed will undoubtedly print more money, just like during Covid. In that scenario, gold is going much higher. To counter any recession, Fresnillo will remain a core part of my portfolio.
