The "Holy Grail" Of Precious Metal Stocks: Harris Kupperman

"The holy grail of precious metal investors has been a business that has upside torque to prices, yet doesn’t have the drama of mining..."

One of my favorite investors that I love reading and following, Harris Kupperman, has offered up his thoughts on precious metals and his favorite mining stocks this week.

Harris is the founder of Praetorian Capital, a hedge fund focused on using macro trends to guide stock selection.

Harris is one of my favorite follows and I find his opinions - especially on macro and commodities - to be extremely resourceful. I’m certain my readers will find the same. I was excited when he offered up his latest thoughts, published below (slightly edited for grammar, bold emphasis is QTR’s).

Please be sure to read both my and Harris’ disclaimers, located at the bottom of this post

On Playing Gold

Last year, I wrote Part 1 of The Great Macro Dreamscape (Part 2 is coming). To summarize, my view is that the coming decade will be the best of times if you can trade and profit from Global Macro, or the worst of times if you’re a peasant trying to survive the Global Macro. Since then, I’ve tried to envision the perfect asset for the coming storm on the horizon. What does well in chaos? What profits on fear? What asset will dramatically out-perform the toxic brew of fiscal, monetary, and governmental chaos that seems almost inevitable?

There are no perfect choices in this world—especially in the world I envision. However, I have millennia of history telling me that in times of crisis, people reach for precious metals to protect themselves—first slowly, then in a panic. Gold doesn’t rally against a dying currency, as much as the market cap of gold swells when denominated in that currency. Capital flees and effectively goes to sleep in the form of precious metals—until stability returns, and capital can be returned to the economy again.

Don’t get worried that this is another doom-porn blog post about gold. I wouldn’t do that to you. I see opportunity in chaos. Let others do the fear and despair part. I only want to win.

So, what wins when gold goes up? We all know that you can play futures, but financial leverage cuts both ways—besides, no one wants to get margin called on one of the inevitable pullbacks. Miners are a joke. They have no leverage to gold. Every pitch is the same, mostly ending in sorrow. 

Royalty companies have become the instrument of choice, but Franco Nevada’s (FNV – USA) experience in Panama instructs us that the royalty companies take on the same jurisdictional risks as the miners. Eventually, everyone will realize that the royalty companies are just sophisticated Return-of-Capital “Ponzi Schemes,” masquerading as gold leverage. They raise capital at one multiple, invest it in an asset at a much lower multiple, harvesting the spread for shareholders. It works as long as the Ponzi economics continue to work, but it isn’t sustainable. If they can’t keep raising capital, the impairments will catch up with them and bury the scheme. In the increasingly volatile world I envision, there will be many more Panama-like situations, which will collapse the multiple and end these “Ponzi Schemes.” This isn’t my asset either.

Besides, while I think that gold goes dramatically higher, I don’t really want to play that aspect—it’s almost secondary in my mind. When I try and think it all through, the gold price is really just an indicator for the global level of fear, with a floor at the cost of production. I want to play the fear—the visceral and instinctual panic into metals and out of paper. I think that’s the better trade—especially as the elites find ways to cap the price of gold, or at least divert people’s attention from it.

With that in mind, I thought I’d mention that A-Mark Precious Metals (AMRK – USA), is currently my favorite idea in the markets, and the recent gold move to new all-time highs, makes this idea unusually timely. AMRK is how I’m intending to ‘play’ gold.

What is AMRK? It’s a dominant wholesale dealer in precious metals, with a substantial presence in sales to retail consumers, along with ownership in two mints (Silver Towne and Sunshine). They’re fully hedged against metal price moves, and instead earn a spread between the price that they pay and the price that they charge customers, usually referenced to the spot price. You likely know many of their retail-facing brands if you have ever bought precious metals online.

March 2024 Investor Presentation

To give you a sense for the size of this business, in Fiscal 2023, they sold approximately 2.6 million ounces of gold and 156 million ounces of silver, for total revenues of $9.287 billion. The business has many verticals, but at its core, the business thrives on increased transaction volumes, along with increases in spreads between their purchase and sales price.

As I believe we’ve seen since 2020, people tend to buy precious metals during periods of fear. Think back over the past four years, we’ve seen; COVID, lockdowns, QE insanity, George Floyd riots, election chaos, Jan 6, Russia invading Ukraine, and Silicon Vally Bank detonating, just to name a few crazy moments. Each of them has led to spikes in web traffic. Not only do crises lead to demand for metals, but the spreads over spot prices frequently expand, driving profits for AMRK.

To give you a sense of the economics here, in each of the three years from Fiscal 2021-2023, the company earned approximately $7.00 a share per year on average—after many adjustments, including non-cash amortization, gains on remeasurement, and a stock split. Please review the financials if you want to better understand these adjustments. However, I’m comfortable in saying that in times of fear, individuals reach for metals, causing spreads and volumes expand, hence AMRK does quite well.

Let’s fast forward to the past three quarters. Until a few weeks ago, gold was rangebound and nothing much was happening to scare people. Think about how mellow things have been, when compared to the constant fear over the past few years. During this more benign period, earnings have been trending in the $2.50 to $3.00 a share annual range. I think this is something of a baseline for the business. With the shares closing at $32.73 on Friday, that would imply a 11 to 13 times earnings multiple for this business, which simply seems low, for trough earnings, given the amazingly high returns on capital that the business has had over the years, even during periods where results have been weaker.

However, what’s important, is to know what you’re playing for. In an environment where demand for metals may expand back to the levels of the past three years, I think AMRK can earn up to $10.00 a share. This higher earnings level is a function of recent acquisitions, a larger balance sheet which can hold more inventory, a reduced share count after recent buybacks and capacity expansions at their own mints. Should the company be able to earn this $10.00 a share, I don’t see why a 25-times multiple (representing $250 a share) is unreasonable—especially as I believe the royalty companies are inferior businesses with depleting mine-lives, and substantially higher risk profiles, yet they trade at higher multiples. In my mind, AMRK trades cheaply, only because most investors do not yet know about it or associate it with the preferred way to “play” gold. Please, don’t take this as investment advice.

I think that will soon change. AMRK functions like an exchange—the sort of business that historically has had rather elevated earnings multiples. This is because the business prospers on volumes. Meanwhile, the elevated returns on capital, allow them to fund acquisitions, customer growth, buybacks, and dividends. How many gold miners have buybacks? Most miners have anemic dividends at best. They’re capital destructive. Money goes into a hole—never to return. Why would anyone want a shitty miner, when they can own the precious metals exchange and prosper off increased volumes and spreads instead? When this reality becomes better known, I think that AMRK will trade at a premium multiple to the sector, especially as the market cap expands, allowing it to be added to additional passive indexes.

In the interest of fair and balanced reporting, I’d be remiss if I didn’t note that future predictions are speculative and may not fulfill themselves. Moreover, I expect calendar Q1 earnings to be soft, likely down from calendar Q4 results. This is a function of reduced transaction volumes, as indicated by the web traffic that we monitor, along with reduced spreads. However, that is all backwards looking now that gold is making new highs.

That said, it’s important to give you a sense of how spreads matter in this business, in fiscal 2023 and 2022, AMRK earned a gross profit margin of 3.16% and 3.21% respectively on revenue. Meanwhile, in the second quarter of fiscal 2024, the gross profit margin declined to 2.21% of revenue. While this all sounds like a handful of basis points, it’s quite material in terms of the business’ profitability, showing the important of volatility and customer demand, that drives spreads. 

Additionally, Wall Street has historically struggled to understand the business, as the spikes in demand come in unpredictable waves, tied to discrete events. As a result, individual quarters tend to show incredible variability in earnings, mostly driven by changes in spreads. I think that investors will either try and predict the individual quarters, and end up disappointed, or look at the earnings on a multi-quarter basis and take a holistic view that average earnings can be quite strong, with occasional troughs. Meanwhile, those troughs can be used by AMRK to buy competitors and grow the business through using cut-throat pricing to attract new retail customers—as AMRK has demonstrated over the past few quarters.

Wrapping this posting up, I like the high level of insider ownership, the ability of the business to continue to grow through acquisitions, while not materially growing the share-count, the buybacks and dividends, and the torque to transaction volumes as individuals reach for precious metals as the world goes crazy. While I’m only modeling a return to demand trends that existed in the past three years, clearly the business can do a whole lot better should “Project Zimbabwe” become a reality.  

The holy grail of precious metal investors has been a business that has upside torque to prices, yet doesn’t have the drama of mining. Despite an exhaustive search, only AMRK checks that box for me. As far as I’m concerned, there are plenty of gold equities that are suitable for trading, but only AMRK is suitable for owning through the cycle. As the next gold cycle appears to be kicking off, AMRK is my favorite idea in my book.

PLEASE DO YOUR OWN DUE DILIGENCE!

Disclosure: We are long shares of AMRK and FNV.

QTR’s Disclaimer: I am an idiot and often get things wrong and lose money. I may own or transact in any names mentioned in this piece at any time without warning. Contributor posts and aggregated posts have not been fact checked and are the opinions of their authors. This is not a recommendation to buy or sell any stocks or securities, just my opinions. I often lose money on positions I trade/invest in. I may add any name mentioned in this article and sell any name mentioned in this piece at any time, without further warning. None of this is a solicitation to buy or sell securities. These positions can change immediately as soon as I publish this, with or without notice. You are on your own. Do not make decisions based on my blog. I exist on the fringe. The publisher does not guarantee the accuracy or completeness of the information provided in this page. These are not the opinions of any of my employers, partners, or associates. I did my best to be honest about my disclosures but can’t guarantee I am right; I write these posts after a couple beers sometimes. Also, I just straight up get shit wrong a lot. I mention it twice because it’s that important.

Harris’ Disclaimer: Past performance of Praetorian Capital Fund LLC and its feeder fund Praetorian Capital Offshore Ltd. (collectively, the “Funds”) is not indicative of future results. No representations or warranties of any kind are made or intended, and none should be inferred, with respect to the economic return or the tax consequences from a potential investment in the Funds. Each investor should consult their own counsel and accountant for advice concerning the various legal, tax and economic matters concerning their investment. The information provided herein does not constitute an offer to sell an interest in the Funds. Such offer can only be made to qualified investors pursuant to the Funds’ Confidential Private Placement Memorandum (“Offering Memorandum”), the Subscription Documents relating thereto and the Limited Liability Company Agreement, as applicable, which set forth the complete terms of the offer. 

No representation or warranty (express or implied) is made or can be given with respect to the accuracy or completeness of the information found within this website. Certain information constitutes “forward-looking statements” about potential future results. Those results may not be achieved, due to implementation lag, other timing factors, portfolio management decision-making, economic or market conditions or other unanticipated factors. Nothing contained herein shall be relied upon as a promise or representation whether as to past or future performance or otherwise. Please read Harris’ full disclaimer here.