Was Warren Buffett Right About Gold Mining Stocks?

When Warren Buffett bought gold, it made headlines, although it wasn't gold he purchased so much as GOLD stock. Buffett has been bearish on gold for a long time, saying that gold doesn't really do anything but sit there.

However, Berkshire Hathaway's purchase of Barrick Gold shares doesn't necessarily signal a change in view, especially since it seems likely that it was one of Buffett's lieutenants who made the purchase. So will Barrick Gold and other mining stocks pay off in 2021? The bullish scenario for gold makes mining stocks look attractive, but not all of them will pay off equally.

One of the main drivers of gold stocks is the price of the yellow metal. Gold had a strong year in 2020, although it has been trading sideways for months, leaving investors hungering for a repeat of the record high above $2,000 an ounce earlier in the year.

In a "What I Learned This Week" report in December, 13D Research noted that investment demand for gold grew 21% year over year during the third quarter. Investment demand accounted for 55% of total demand.

The rally in gold prices enabled miners to expand their margins and generate record-high free cash flow, Scotiabank analyst Tanya Jakusconek said, according to Kitco. Many analysts are bullish on gold's prospect for 2021. Credit Suisse targets an average price of $2,100 an ounce, while Goldman Sachs is calling for $2,300 an ounce.

In 2020, many gold stocks posted triple-digit gains. K92 Mining was up nearly 170%, while GoGold Resources gained more than 280%. Calibre Mining rose more than 160%, and Metalla Royalty and Streaming was up more than 100%.

John Hathaway of the Sprott Gold Equity Fund told Kitco that gold miners have significantly improved their margins, and production remains healthy. Despite those facts, he has never seen gold mining stocks as cheap as they are right now. He noted that the S&P 500 is trading at 16.3 times EV/EBITDA, while gold miners are trading at 7.6 times EV/EBITDA.

According to Hathaway, investors have been avoiding gold mining stocks for a few reasons. He said investors want to see if the companies learned their lessons from the last gold bull market. The yellow metal soared to record highs in 2011, but miners overleveraged their balance sheets, resulting in terrible margins.

However, this time around, gold miners have boosted their dividends and returned money to shareholders because their greatly improved margins enable them to do so.

For 2021, Ralph Aldis of U.S. Global Investors likes RoxGold, Revival Gold, Barksdale Resources and Magna Gold. According to Kitco, he also advises investors to aim for junior or mid-tier gold miners instead of seniors like Barrick Gold or Newmont.

Aldis explained that senior gold miners like Newmont and Barrick are mostly flat in gold production. He believes they will have to make acquisitions if they don't find new sources of gold themselves. That provides opportunities for smaller mining companies to be bought out. Last year was a weak year for consolidation in the gold mining industry, but Aldis expects it to pick up this year and next.

Hathaway also sees opportunities in smaller and mid-tier gold miners as he also looks for more consolidation in the sector this year. He said that ultimately, the price of the yellow metal is what will draw investors into mining stocks, and 2021 looks to have all the makings of a continued bull market for gold.