The gold price changed little in February; gold stocks are poised to benefit from the recent rise in gold prices.
Gold prices were little changed in February, closing below $2,000 per ounce on February 13 and 14 before bouncing back and remaining above this level for the remainder of the month. Gold finally settled at $2,044 per ounce on February 29, up 0.23% for the month. US headline figures and the Consumer Price Index (CPI) for January were above consensus expectations, pushing back the likelihood of a US Federal Reserve (Fed) rate cut to later in the year and putting pressure on the gold market in mid-month. Gold later found support to average an average closing price of $2,029 per ounce so far this year – not too bad considering that over the same period the US dollar has risen 2.8% (as measured by the DXY Index1) and demand for investments in physical gold (measured by positions in gold-backed ETFs) has fallen by 3.7%.
While physical gold was seemingly unloved last month, gold stocks were actually heartbroken. The NYSE Arca Gold Miners Index (GDMNTR)2 and the MVIS Global Juniors Gold Miners Index (MVGDXJTR)3 fell 6.10% and 6.84% respectively in February, widening the already significant valuation gap against the metal increases. However, the early days of March have brought some relief for gold stock investors, with gold mining stocks significantly outperforming physical gold as gold hits new all-time highs. This could be the start of a reversion to the mean, with gold mining stocks once again showing their leverage on the gold price and outperforming physical gold when the gold price rises. For reference, GDMNTR would need to more than double from current levels to reach the August 2011 peak – so there still appears to be a decent potential growth path based on historical performance alone.
We attended the BMO Global Metals, Mining and Critical Minerals Conference last month. We met the management of more than 40 gold and precious metals companies. This conference provides an excellent opportunity to gauge the pulse of the industry, identify trends and themes, and get updates from the individual companies, while potentially discovering new investment ideas. These are some of our key points:
- Location, location, location — It is no secret that mining companies face many risks associated with the regions where they operate. However, it is important (and necessary if you want to invest in the sector) to distinguish between broader jurisdictional risks and risks specific to We have met with companies with projects in regions/jurisdictions considered geopolitically risky – including in countries such as Peru, Ecuador , Guyana, Nicaragua, Papua New Guinea and Ethiopia – but where management apparently enjoys operational stability in these places. Ivory Coast and Guinea appear to be seen as places of stability in the complex West African region. West Africa, a challenging jurisdiction due to its geopolitical landscape, remains one of the best regions to discover and develop gold resources from an exploration, licensing, labor and capital efficiency perspective. Although companies appear to be more cautious about the ongoing changes and developments taking place in countries such as Argentina, Colombia and Mexico, the overall outlook for mining exploitation and investment appears optimistic.
- Creating expectations — Companies are well aware of the importance of achieving announced We have communicated the urgent need to develop detailed methodologies that will allow companies to do this successfully, given the complexities and many variables involved in forecasting production, business and capital costs for activities and projects. Companies with sophisticated and conservative guidance setting processes should benefit from the significantly higher valuation multiples that come with meeting or exceeding expectations.
- Again to focus on cost control: Following a wave of inflation that has significantly increased operating and capital costs in recent years (mostly beyond the control of the mining companies), there is a renewed focus on implementing cost controls and initiatives for Anecdotally, we also heard that Australian labor inflation after decreases for two years. It appears that inflationary pressures have subsided, which, combined with companies’ efforts to reduce costs, should keep average costs for the sector at current levels.
- Free cash flow is abundant: Although rising production costs have put pressure on margins, at current gold prices companies are generating a lot. For example, one of our mid-tier holdings, with a market capitalization of $1.5 billion, holds more than $640 million in cash, with no debt. The company is paying dividends and trying to make acquisitions to put some money to work. However, with an operating cash flow of more than $400 million per year, the company appears poised to further replenish its coffers. This bodes well for dividend-seeking investors as companies commit to setting sustainable base dividends with the potential for bonus or special dividends as free cash flow increases.
- Acquisitions bring challenges — Whether at the asset or business level, the integration of new projects and activities brings risks and challenges. Acquiring companies must provide updated strategies, restructuring plans and operational and financial forecasts. This increases the risks for these companies and creates uncertainty in the markets. Companies must be able to manage these risks in their pursuit of growth and value creation. In the long run, acquisitions will pay off for strong management teams. In the short term, however, these acquisitions may cause an oversupply of their shares
The gold mining industry is without a doubt a very challenging sector. We spent most of our time at the conference discussing with management their strategies and how they are addressing what we believe are the biggest risks for any business. We are encouraged to see gold mining companies focusing their efforts on reducing risks to their businesses, lowering costs, improving shareholder returns and pursuing disciplined growth with the participation, support and benefit of host countries and communities in an environmentally responsible and ethical manner.
