The year has certainly started very well for almost every asset class and currently, all the main global equity indices are well and truly in positive terrain. Just look at FTSE 100 and FTSE 350, for example. The British indices are up 9.1% and 9.5% respectively. And if we look at FTSE 350 sector indices table below, we see that there are only two sectors in the red.
Ranking them from high to low in terms of performance results in a list where the leader is up more than 30% (Forestry & Paper). Unfortunately, for two sectors, recent this year has not started well and they are now down 0.6% and 3.2% respectively. The worst performer are Mining and Industrial Metals.
Unlike other assets, commodities haven’t been performing to script this year however and Gold in particular is down 5.8% and has many commentators scratching their heads over its performance given the ongoing QE programs that should, they reason, have pushed the price higher. Even Soros has sold down his position in the currently un-shiny metal to avoid being caught on a lasting bear market.
Whilst we believe that the gold price will base around $1200/oz eventually, we do think that the disjoint in valuations between the gold mining sector and the yellow metal has now reached extreme proportions and that a buying opportunity is now present. We will unveil our top picks in the next edition of our magazine out at the end of March and which will join Avocet Mining on our Conviction Buy list.
Let’s take a closer look at gold versus gold miners now to see just how the disjoint compares relative to history. The discrepancy has happened just a few times before, with the last being seen in 1999 – right before the spectacular bull run in Gold started.
To illustrate just by what degree the gold miners have underperformed gold, take a look at the chart below which relates the SPDR Gold Trust relative to the Market Vectors Gold Miners. The first is a great surrogate for gold and the second similarly a good gold miners tracker.
In the middle of 2008, gold miners dropped with the whole equity market due to the great financial crisis. Given the operation leverage to the gold price that the gold miners have with largely fixed costs against a varying sale price, it is no surprise that in a gold bear market that these companies perform much worse than gold. With the start of the recovery later in 2008, the gold miners sector performed very well and started to fill the gap with the gold price but, since September 2011, the link has well and truly been lost again. Is the sector predicting a major loss in the gold price? That’s possible.
Here at SBM we have been bearish on gold for several reasons, and you can learn more about these by clicking the link at the bottom of this page. However, even on our worst case assumptions, we cannot justify the gap in valuations between many of the companies and the underlying gold price and if we are wrong on our target for the gold price and it remains stables or rises, then there is very real upside in some of these stocks.
Let’s look at the performance in recent years of some of the FTSE 350 gold miners in the next table.
The Gold Trust and the Gold composite have both dropped around 14% since September 2011, but our miners have underperformed dramatically compared with the gold price. Randgold has been the “best” performer with a loss of just 16.4% during this period whilst all the others have lost in excess of 40%. Since the beginning of the year, Centamin is the only exception to our deep in the red list of miners and mostly due to its bounce back from the exceptional losses registered in 2012.
If we look at the evolution of the price action in the miners and gold itself since the market bottomed in October 21, 2008, we can see that the FTSE 350 sector as a whole has gained 79%, gold almost 100% but the miners, with exception of Randgold have all underperformed dramatically with Avocet being the worst case. Such magnitude of underperformance will likely correct either on the gold side (going down extensively to sub $1000/oz as implied by some valuations) or on gold miners side (going up – in some cases by 50-100%).
When we take a look at the most important measure of value for a gold miner the price to book value – this throws up some raging bargains. Price to book is a measure of the price of a stock relative to its NAV – if less than 1 this means it is trading cheaper than the underlying value of its mining assets. Many gold miners are trading much below their book value meaning the company has less value as currently as a going concern than if its assets were to be sold separately. This is why we think that M&A activity is likely to be ratcheted up dramatically as the year progresses if these discounts persist.
On a price to book basis Petropavlovsk shows a ratio of 0.52 and Avocet a very lowly 0.18 although this was before the asset write downs this week – the new value is around 0.29 times. Amara Mining and Aureus with price to book ratios of 0.74 and 0.84 respectively also look attractive. Be sure to read our next edition for more in-depth analysis on 3 top picks.