With gold mining stocks trading at the lowest level since 2008, we believe they have reached a point where upside potential now far outweighs downside risks, making this a good entry point for investors with medium-term time horizons……
Although we estimate gold miners still may have a further US$113bn of reserves to write-down, with gold miners’ share prices down 52% over the past year and 66% over the past 3 years, we believe much of this expected write-down is already in the price. On our estimates, gold miners’ shares are currently trading at a 4% discount to their book value and many are now trading at attractive long-term accumulation levels. With the gold price having stabilised around the US$1,250oz level and general equity market sentiment expected to remain positive, gold miners appear to be in a position to outperform gold. If shares were to rebound back to August 2013 levels, the DAXglobal Gold Miners Index has potential for significant upside from where it stands today.
– Gold miners’ fundamentals are finally improving, with costs falling 15% in Q3 2013 compared to the previous quarter.
– Gold miners are trading at a 4% discount to net asset value (NAV) on our estimates, the lowest level on record.
– We believe that gold miners’ discount to NAV is unsustainable and that share prices will start to outperform the gold price now that global growth is gaining pace and equities remain in favour.
Write-downs: all done or more to come?
Major senior and mid-tier gold miners were forced to write-down their assets by an aggregate US$27bn in Q3 2013. While the write-downs were long overdue with the gold price currently trading US$300/oz below miners’ long-term expectations, further write-downs are still necessary. Miners may be forced to reassess the value of their reserves under more conservative assumptions that may render some assets uneconomical to mine. At the end of 2012, the dollar value of gold mining reserves assumed a long-term gold price that ranged from US$1,500oz (for Barrick Gold) to US$950oz (for Yamana Gold). With the gold price currently trading around US$1,250oz, most gold miners will have to devalue assets further and possibly close more mines.
Barrick Gold recently announced its intention to recalculate its reserves based on a US$1,100oz level and others are expected to follow its example. We estimate this could result in a US$113bn loss in reserves (based on a conservative figure of US$1,200oz gold price), four times more than the write-downs carried out in Q3 2013. However, with gold miners’ share prices (as measured by the DAXglobal Gold Miners Index) down 52% in 2013 and 66% over the past 3 years, we think that much of this expected write-down is already factored into prices.
While costs remain a key concern, miners have made good progress in containing expenses and closing down loss-making mines. All-in costs in Q3 2013 were 15% lower than in the previous quarter due to a reduction in capital expenditure and exploration costs. While this might be detrimental for miners’ production in the long run, it will likely have a positive impact on profitability and, in turn, should help support miners’ valuations. According to Thomson Reuters GFMS , less than 10% of the industry would be unprofitable at current price levels.
Gold miners’ shares are currently trading at a 4% discount to their book value, according to our calculations. The book value, also often referred to as the net asset value (NAV), is the theoretical value of a company’s assets net of liabilities. Companies whose share prices are trading below NAV can theoretically be viewed as an acquisition target as the sum of the net assets is worth more than their share price. Therefore, the fact that gold miners are trading below estimated NAV potentially sets a medium-term base for the share price. In our opinion, potential further write-downs have already been reflected in the price and gold miners may now have returned to attractive long-term accumulation level. Management issues aside, the recent weakness in the gold price may have hindered the relative performance of gold miners’ shares. Prior to 2013, the last time gold was around US$1250oz was in June 2010 when gold miners’ shares were trading 111% above current levels. With the gold price now appearing to have stabilized around the US$1,250oz level, if general equity market sentiment remains positive, we expect mining shares to return to trade above book value. Historically, gold miners have tended to outperform the gold price when global business activity, as measured by the OECD World Lead Indicator, has been high and rising. Conversely, the gold price has tended to outperform gold miners when growth has been slowing and the global economy has been in a downturn, as in the aftermath of Lehman Brothers’ collapse.
With global growth finally starting to gain momentum, we expect the correlation between miners’ shares and gold to reduce and gold miners to start to outperform gold.
On our view that valuations will move back to at least October 2013 levels when gold miners were penalised for their initial write-downs. Should investors become convinced that miners’ are able to maintain profitability at current lower gold price levels we believe the re-rating could bring the index back to August 2013 levels, providing potential for significant upside from current levels.