Shares in FTSE 100 precious metals miner Fresnillo (LSE: FRES) fell sharply on Friday (5 June) after a stronger-than-expected US jobs report dampened hopes of interest rate cuts.
But I think the market may be missing something.
The same economic strength that’s keeping inflation concerns alive is also one of the main reasons investors own precious metals in the first place.
If inflation remains stubbornly high, should investors really be selling precious metals stocks?
Persistent inflation
When discussing gold and silver, most investors immediately focus on interest rates. But the longer-term investment case is often about purchasing power.
Inflation gradually erodes the value of cash and fixed-income assets, like bonds. Over long periods, currencies lose buying power as prices rise across the economy.
That’s why many investors choose to hold precious metals. Unlike paper currencies, their supply is limited, and they have historically been viewed as stores of value during periods of elevated inflation and monetary uncertainty.
Recent economic data suggests the US economy remains remarkably resilient. While that may reduce expectations for near-term rate cuts, it could also make returning inflation to a target level more difficult.
If inflation proves more persistent than markets currently expect, the long-term case for owning precious metals may remain intact.
Mounting debt
The market’s reaction also assumes policymakers can keep interest rates higher for longer if inflation remains stubborn.
I’m less certain.
Governments around the world are carrying far more debt than they did in previous inflationary periods, making higher borrowing costs increasingly painful over time. That may limit how much higher interest rates can go from here, even if inflation proves difficult to eliminate completely.
If that’s right, inflation could remain elevated for longer than investors currently expect. And that is precisely the type of environment where many investors turn to precious metals as a store of value.
Investment case
If that view proves correct, Fresnillo could be an interesting beneficiary.
What attracts me is the gap between current precious metals prices and the company’s production costs. Even though costs vary across its operations, Fresnillo remains profitable at significantly lower gold and silver prices than those seen today.
That matters because mining profits are rarely linear. Once costs are covered, a sustained increase in commodity prices can have a disproportionate impact on earnings and cash flow.
In my view, investors may still be underestimating what a prolonged period of elevated gold and silver prices could mean for profitability. The company has yet to report a full year of results against the backdrop of today’s stronger precious metals prices.
The obvious risk is that I’m wrong. If inflation falls back towards target and precious metals prices weaken, margins would inevitably come under pressure.
In addition, the miner faces operational risks and could also be affected by changes to regulations, taxation or mining concessions.
However, for investors who believe inflation may prove more persistent than markets currently expect, the recent weakness could be worth a closer look.
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Andrew Mackie owns shares in Fresnillo.
