- The pause provides an opportunity for investors not only to continue building positions in the physical metal following the sharp rally from the March, 2020 lows, but also to refocus on the gold mining sector which should see multiple drivers beyond rising gold prices as a performance catalyst.
- Historically, low energy prices and falling local currency production costs mean that gold miners will see their costs fall by as much as 13% to USD 900/ounce or more than 50% below current spot gold prices.
- Strong cost management combined with the bull market in the underlying metal suggest that high quality producers may see rising dividends as well as value accretive acquisitions looking ahead.
Gold bull market set to resume going into 2021
The inability of US fiscal authorities to agree on additional relief measures ahead of the November US elections and the hesitance on the part of the Federal Reserve to fill the policy gap that has emerged to support the recovery has resulted in a correction in the gold bull market that began with the end of theFed’s last rate hiking cycle in late-2018.
However, once the election season passes, we expect thatUS fiscal resolve combined with the resumption of Fed support via bond buying should provide the next tailwind to the gold bull market.
Fundamentals add near- and medium-term drivers to gold miners…
During this transition, investors looking to build positions in the sector should search beyond simply the physical metal and also consider gold miners where fundamental catalysts put in place during the previous bear market have already begun to serve as a tailwind to earnings as an additional driver in the months and years ahead.
With the combination of rising gold prices and falling energy costs, margins for the sector have already reached the levels seen at their previous peaks. This margin expansion alone has driven earnings growth in the sector to a pace beyond that seen at the height of the 2000-2011 bull market.
Despite this, the coming quarters should see an additional earnings catalyst as companies report their results. The lockdowns in early 2020 hit mining companies particularly hard as mine closures due to spreading COVID-19 infections stalled production growth, limited sales and constrained earnings growth in the period.
Beyond resuming production at previously shuttered mines to drive near-term earnings surprises, investors could see more medium-term benefits as well. This emerging cost and margin dynamic means the potential for a new free cash flow regime for the sector, historically known in previous cycles asa consumer rather than a generator of cash.
This cash generation should provide flexibility amongst some of the sector’s largest producers to continue raising dividends, increasing total returns to shareholders in the process.
Positioning in the gold mining segment
Admittedly, the gold mining sector as a whole has historically been a destroyer of value for shareholders due to imprudent deployment of capital usually near the peak of the long mining cycle, resulting in a high degree of volatility in mining shares.
Indeed, in the most recent bear phase from 2011 to 2018when gold prices fell nearly 45%, gold mining stocks lost84% on aggregate from peak to trough. In the current bull market, a passive investor in gold mining stocks has outpaced the 45% rise in gold prices since early-2019, more than doubling the initial investment outlay. As a result, we recommend an active, quality-biased stock selection focused approach when investing in the gold mining segment.