Why I’m ‘keeping the faith’ with Fresnillo

One of the most difficult parts of being an investor is living with paper losses. Inevitably, there is a degree of frustration when an investment doesn’t go quite as planned.

I’ve experienced this lately with a shareholding in precious metals miner, Fresnillo (LON:FRES). It’s down around 7% since I bought it. Although a disappointing performance thus far, the fundamentals and the reasons for its purchase have not changed all that much.

Therefore, I’m ‘keeping the faith’ with it. However, doing so is not always straightforward, with many investors struggling to face the challenges which come with holding onto shares with paper losses. One of the best means of doing so is refocusing on the reasons behind the purchase, and judging whether the same decision would be taken today with fresh capital.

In Fresnillo’s case, the outlook for gold remains positive due to the prospect of higher inflation and greater uncertainty. The company’s shares are even cheaper than they were last year, while its outlook remains relatively upbeat.

Coping with loss

While there is no fool proof strategy to cope with a decline in the valuation of a stock holding, managing expectations can be a prudent means of overcoming paper losses. In the case of Fresnillo, it is a long-term position. When purchased last year, it was expected to be a multi-year holding, since the factors behind its upbeat outlook may take time to come to fruition. Therefore, by reminding oneself that it can take time for positive catalysts identified upon the purchase of shares to work their way through to the share price, it can make it easier to cope with short-term losses.


Additionally, the reality of investing is that share prices fluctuate. In the case of mining stocks such as Fresnillo, they can easily move 7%+ within one day. Therefore, a loss of today could easily be a profit by tomorrow.

Further, the rationale behind the purchase of Fresnillo has not changed materially in the last few months. Reassessing a company’s investment potential from as much of an objective standpoint as possible can help an investor to discover if holding or selling is the optimum strategy. Ultimately, if the outlook has changed and there is more risk than reward, it can be prudent to jump from a sinking ship. Should the reasons for buying a company’s shares be little changed versus the date they were purchased, buying more shares could even be the most logical option.

Looking towards profitability

Admittedly, the performance of Fresnillo and the wider gold mining industry has not been as positive as expected. The price of gold has not risen by as much as I anticipated in the last few months, despite it being up 8.9% since the turn of the year. The general opinion among many investors was that Donald Trump’s Presidency could lead to great uncertainty in stock markets across the globe, meaning a ‘risk-off’ attitude from investors. The opposite has, in fact, been true.

Fresnillo’s valuation appears to be more appealing today than it did last year.

Looking ahead, uncertainty could build. Already, a number of Trump’s plans have hit roadblocks. For example, his spending plans may need to be changed in order to pass through both Houses.

However, the main catalyst for the gold price looks set to be inflation. Trump has outlined major rises in defence and infrastructure spending, as well as lower taxes, as he looks to pursue a looser fiscal policy. This could lead to higher inflation further down the road, with the Federal Reserve unlikely to keep up with the curve due to time lags and an inertia about raising rates too quickly following the biggest recession since the 1930s. In such a scenario, gold could be seen as a natural hedge against inflation and this may lead to increased demand from investors. A higher gold price could follow in future years.

A better valuation

As with any share that falls in price and yet continues to offer the same growth outlook, Fresnillo’s valuation appears to be more appealing today than it did last year. Its EPS is forecast to rise 27% this year and 35% next year. Some of this is due to a higher gold price, but the majority of it is down to changes made in the company’s business model and from positive foreign currency fluctuations.


For instance, in 2017 Fresnillo is guiding towards silver production of 58-61 moz, while in 2018 it is targeting production of 65 moz. This compares with production of just over 50 moz in 2016. Although gold production is forecast to fall to 870-900 koz in 2017 from 935 koz in 2016, a weaker Mexican peso versus the US dollar should help to keep production costs down. As mentioned, higher inflation could spur US interest rates higher, leading to a further strengthening of the dollar versus the peso. Therefore, Fresnillo could see its production costs fall yet further in dollar terms. This could improve its profitability and send its share price higher.

Outlook

While disappointing, experiencing paper losses is part-and-parcel of being an investor. The rationale behind a share purchase can take time to prove correct in the form of a higher stock price. In the meantime, managing expectations in this regard, while also reassessing the justification for buying the company in question from an objective standpoint, can help an investor to overcome the frustration of being in the red.

In the case of Fresnillo, remarkably little has changed regarding its outlook. Higher inflation looks likely to emerge, while uncertainty may increase in future months. A rising US interest rate plus higher silver production in 2017 and 2018 could lead to an increasing share price. For these reasons I’m ‘keeping the faith’ with Fresnillo. After all, a 7% loss can easily become a 7% profit in what remains a highly volatile precious metals mining sector.