The Chinese translation is being made; the original is shown for now.
(Kitco News) - The ongoing war in Iran and disruptions to global energy supplies are driving inflation pressures higher, forcing central banks to maintain restrictive monetary policies, which is taking its toll on gold; however, one fund manager says the conflict is only delaying gold's eventual rally, while the mining sector continues to generate significant cash flow at historically elevated prices.
In an interview with Kitco News, Chris Mancini, co-portfolio manager of the Gabelli Gold Fund (GOLDX), said that if the conflict in Iran and disruptions to oil shipments through the Strait of Hormuz had been resolved during the summer, gold prices would probably already be trading at $5,000 an ounce.
Mancini explained that the conflict has created a difficult environment for gold as higher energy prices fuel inflation, raising expectations that the Federal Reserve will continue increasing interest rates.
However, he sees the current environment as a temporary obstacle rather than a fundamental threat to gold's long-term outlook.
Mancini said that even if the Federal Reserve continues raising interest rates to combat inflation, higher borrowing costs and elevated oil prices will eventually take a toll on economic growth, forcing the central bank to reconsider its monetary policy stance.
While gold investors continue to wait for a renewed rally, Mancini said that mining companies remain in a strong position to capitalize on elevated prices, even as they face rising operating costs.
With the mining sector preparing to report third-quarter earnings, Mancini said he expects companies to report strong profits and substantial free cash flow. However, he warned that higher energy and labor costs could cause some producers to miss analysts' expectations.
"I think the big picture is that it's going to be very good earnings, but they'll probably miss a lot of consensus estimates," he said.
Nevertheless, Mancini argued that investors should look beyond any disappointing headline numbers and focus on the industry's underlying profitability.
"I think that the big picture, if you take a big step back, is that they're still going to be generating lots of free cash flow and reporting really good earnings," he said.
Although higher diesel prices are creating significant headwinds for producers, Mancini noted that labor remains an even bigger cost pressure.
He explained that labor inflation is being driven partly by increased development activity, as mining companies look to build new projects and expand production to take advantage of gold prices near $4,000 an ounce.
"At $5,000 an ounce gold, they should be building projects. At $4,000, they should be building projects," he said.
However, Mancini doesn't see the same reckless spending that characterized the previous gold bull market in the early 2010s.
During that period, he said, companies were under significant pressure to demonstrate production growth, often pursuing expensive and technically challenging projects regardless of their economic viability.
In contrast, Mancini said that companies today are generally pursuing more manageable projects with lower capital requirements.
"The companies haven't yet gone to trying to build these really extravagant, high-cost, high-capital projects," he said. "So the costs should be more contained this time around than they were last time."
Mancini added that the industry's improved capital discipline is one of the biggest differences between the current bull market and the previous cycle.
However, despite stronger balance sheets, substantial free cash flow and more responsible spending, he said gold-mining equities continue to struggle to attract broader investment interest.
Reflecting on discussions at a recent mining conference in Denver, Mancini said that sentiment among mining executives and dedicated gold investors was generally positive, but there was little evidence that generalist investors were becoming more interested in the sector.
"These stocks are really cheap, but there still wasn't any interest, I don't think, from generalists," he said.
Mancini explained that many investors remain skeptical about the sustainability of elevated gold prices following previous cycles in which sharp rallies were followed by prolonged downturns.
He said that a sustained recovery in gold prices would be an important first step in attracting broader investor interest.
However, he also believes mining companies need to change how they return capital to shareholders.
Although many producers have used their strong cash flows to repurchase shares, Mancini argued that higher dividends could do more to attract investors who have traditionally avoided the mining sector.
"I don't think the market pays attention to buybacks. I think the market will pay attention to dividends," he said.
He pointed to Newmont as an example of how mining companies could make their shareholder returns more attractive.
According to Mancini's estimates, Newmont, with a market capitalization of roughly $120 billion, could repurchase approximately $8 billion in shares this year while paying about $1 billion in dividends.
He explained that although the company's total capital returns could represent roughly 8% of its market capitalization, investors focusing on its dividend yield see a much smaller return.
Mancini argued that if mining companies shifted more of their cash distributions from buybacks to dividends, investors would be more likely to recognize the sector's value.
"If they were to see an 8% dividend yield, they'd be like, wait a second, what's going on here? That's a big dividend. That's a big yield," he said.
He added that higher dividends could also help mining equities distinguish themselves from physical gold, which continues to struggle as a non-yielding asset in an environment of elevated interest rates.
While Mancini remains optimistic about the mining sector's long-term prospects, he acknowledged that the timing of gold's next major rally remains uncertain.
He said the labor market could provide an important catalyst, particularly if the economic damage from higher energy prices and restrictive monetary policy becomes more apparent.
Mancini suggested that a significant deterioration in employment could quickly force the Federal Reserve to change its policy outlook.
He said that if the October employment report, due in early November, shows the U.S. economy losing 100,000 jobs, gold prices could spike as investors anticipate a pause in the central bank's tightening cycle.
See live precious metals prices for gold, silver, platinum and palladium — in USD, CAD and 12 more currencies.
Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.