Gold miners’ shares have fallen over 50% since the beginning of 2013, back to the level reached in the aftermath of Lehman Brothers’ collapse in 2008.
Although gold miners have historically tended to trade at a substantial premium to the broader mining industry, their valuations have now fallen substantially below that of most other equity sectors including the materials sector.
While the bottom of the de-rating might not have been reached yet, we believe that most of the write-offs have already been reflected in market valuations. Current depressed share price levels appear attractive to begin to build positions in gold mining stocks.
Gold Miners Might Have to Write Down Their Assets
With gold bullion slumping into a bear market, gold miners might be forced to write down the value of their assets by year-end. Newcrest, one of the top ten gold producers, has already announced it will reduce the value of its mines by as much as US$5.6bn, after having lost half of its market capitalization since April 2013.
Other miners are expected to follow Newcrest’s steps when they report annual results, as most companies valued their reserves assuming a gold price of US$1,300oz or higher. Gold miners will be reporting earnings over the next four weeks. While some write-downs are likely, downside appears limited given recent sharp share price moves down, opening up opportunities for investors to begin to accumulate positions.
Miners are Trading Below their Book Value
Gold miners’ shares are now trading at an 8% 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, the recent correction in miners’ shares has therefore been excessive and gold miners may now have returned to attractive long-term accumulation levels.
Gold is Trading Close to Average All-In Costs
According to Thomson Reuters GFMS data, at current price levels, around 50% of global gold production would be unprofitable. Although it might take some time for production to adjust to lower prices, some miners are already cutting labor capital and exploration costs that will in turn lead to production cuts, as the gold price is hovering around the cost of production. In the long run we believe that the current situation is not sustainable and the gold price will have to increase to compensate for rising extraction costs, declining ore grades, and reserve replacement. Although so far gold miners have been able to compensate declining rates through increasing reserves, scarcity of new discoveries might represent a hurdle.
Embracing high-margin low-cost strategies like reducing capex and exploration costs and focussing on a more disciplined capital allocation might be one of the simplest and fastest ways to add value. Consolidation at industry level could also be an effective way to create economies of scale and improve efficiency, thereby improving the bottom-line and supporting share prices.
Conclusions
Gold miners have historically tended to outperform gold and broad equity indices during periods of rising global growth. However, gold miners’ valuations have now dropped from a substantial premium, to over 50% discount to broader mining sector valuations. In the next few weeks, as miners report results and are forced to write-down assets, there might be some near-term downside potential for their share prices. Despite this, the sharp drop in gold miners’ prices to below book-value and the substantial discount to other mining companies, we believe that in the coming months there will be opportunities for investors to begin to accumulate positions.