How to pick a better gold investment
Some of my favorite oxymorons are words like “act naturally,” “random order” or “jumbo shrimp.”
As a guy with a sense of humor, I enjoy laughing at things like this. Some might say “value investing in gold” is an oxymoron too. Typically, gold stocks seem tied lock-step to the latest political uproar, not the quality of each gold company. But for every occurrence of gold fever, the crazed cycle of trend investing usually leads to gold headaches instead — for both investors and mine management.
Let’s look at why value gold investing might actually be an oxymoron that makes sense.
The latest gold rush
Recently many players on both sides of the business, companies and investors, gathered in Colorado at two industry events. The Precious Metal Summit in Beaver Creek brought together 185 companies and close to 300 investors. The strong attendance shows a good level of interest for an industry buoyed by the recent price rise.
Economic and political uncertainty is still driving the gold price upwards in the market. Brexit sits unresolved in the UK as Parliament looks to be in a stalemate. In Hong Kong, pro-democracy rallies continue to rock the financial center of Asia. Meanwhile, the trade and tariff wars threaten USA and China relations, while domestically in the US threats of a presidential impeachment are rattling the markets. There are signals in the market for both USA and the ECB to lower interest rates as was shown by the Federal Reserve Bank and many expect additional quantitative easing to come this fall.
All of these amazingly awful events supported the recent run-up in gold prices to US$ 1,400 and now US$ 1,500 per ounce. Adding to this was the recent attack on key oil production facilities in Saudi Arabia. This caused concern for ongoing Middle East stability that pushed gold prices up 1% that week. As stated in my July 30th note these factors underpinning gold will not be resolved in the near-term.
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Pick the right pony?
Keynote speakers at Beaver Creek presented a couple of ways for investors to participate in gold mining investment. The first theme is that of consolidation. The past years saw two of the largest mergers in the industry, Newmont with Goldcorp, and Barrick with Randgold. The verdict is still out on whether these mega mergers will create value for the shareholders and the sector.
But more potentially profitable mergers will come. With 185 companies at the conference there is still talk that there are too many for the sector, and in particular in the intermediate producers. Making the investment thesis, pick the story you think is going to get merged, at a premium of course. However, one investor noted that in many cases the real winner in the deal is the seller.
Recession is good for the gold sector. Really?
In the second keynote talk focused on the changing economic conditions pushing the gold price higher. The world is heading for a recession and the central banks and governments will do whatever it takes to keep the economy going. The suggested method is cheap money; that will drive the price of gold even higher. The gold price is in a secular bull market having broken out in all major currencies. Much higher gold prices will bring in the money to the sector as a flight to safety.
This theme was repeated at the Denver Gold show, with several well-known mining executives calling for multiples to the current gold price! Do these price calls really help our industry? Do we need these prices to actually make the investment worth while? To be blunt, is gold always a speculative play?
It is an open secret that gold players need to attract significant risk capital to start, build and grow. As the gold price rises, trend investors can meet that need. But wait. Are we going to only rely on the cycles of high gold prices or attractive M&A premiums to somehow make strong companies? Or can companies make a business case to attract new investors?
Concerned Investors speak
In contrast to this, the Shareholders Gold Council, a group of 19 investors including Paulson and Co., noted from the conference sidelines that gold miners spend more on general and administrative costs than their base metal peers. They estimated a staggering US$ 13 billion in investor value could be unlocked by adopting better business practices in the sector. They would like to see the additional cash generated by the margin expansion to be returned to the risk capital investors in dividends, not put into chasing growth.
So just how should the gold investor profit? Should they hope to pick the right stock for a merger; bet that gold prices continue their bull run; or use their voting power to push for a return of capital from investor-focused management teams?
In my practice, we are looking for management teams who are committed to building profitable projects and delivering yield to the investor, not simply waiting for higher prices or a take out to make their projects look good on paper. We want to identify those companies where the success of the business stays within the control and talents of management operating good projects rather than chasing the whims of market hype.
Ronald Wortel, MBA, P.Eng. is a mining investment professional with extensive experience in analysis of companies, projects and markets. He worked as both a sell-side ... <Read more about Ron Wortel>