Time to look at gold miners?
While The Montgomery [Private] Fund has not held shares in gold producers since 2012, in recent weeks our interest has been piqued. In this article, Tim Kelley talks about the arguments for and against owning shares in gold companies.
Gold is something that has piqued our interest in recent weeks. Since late last year we have seen some precipitous falls in the share prices of gold producers, largely driven by a declining gold price. In fact, looking at a sample of ASX-listed gold companies, the average share price fall since October is close to 60 per cent. It’s beginning to feel like the market may have overreacted.
When we say “gold”, we should add that our focus for the moment is on gold producers, rather than the metal itself. Investing directly in the metal requires a confident view on where its price is going, and for us to have that sort of confidence requires a level of self- delusion that – for the moment – is lacking. More on that later.
We do need to acknowledge that further large changes to the gold price will have a big impact to the fortunes of gold producers, and so we can’t put our head in the sand in respect of them, but if we can see good value in gold producers based on the gold price remaining broadly where it is, that can stack the odds in our favour, possibly enough to justify the risk.
Before you ask, we should also add that Newcrest Mining is not among the companies we are looking at. Newcrest has consistently dismal economics and we have never understood why our peers have been willing to pay the prices it has previously traded.
Today, with the price having fallen by almost 60 per cent since its peak in September 2012, Newcrest still looks expensive in our estimation and our interest in it remains firmly ‘un-piqued’.
What I find more interesting are some of the lower profile gold producers. In particular, companies that may have healthy production growth profiles that the market has lost interest in.
Before we consider their merits, we should return to the gold price. Since October, when it traded at around US$1800/oz, the gold price has fallen by around 25 per cent to now be in the mid US$1300s. During that decline, The Montgomery [Private] Fund has not held the shares of gold companies. In A$ terms however, the decline has been softened by the falling Australian dollar, and the drop in local currency terms is around 17 per cent. This is still a meaningful change, but arguably small compared with the near 60 per cent share price decline for the typical ASX-listed gold
company in the same period.
We can’t exclude the possibility that the gold price will continue to fall. While it is considered a financial asset, gold earns no income, and we know of no reliable way of assessing its “value”. All we can say with confidence is that the current price reflects the market’s best judgement of what gold is worth (for now).
There is a school of thought that says that the gold price shouldn’t fall much further, because many of the world’s gold mines will start losing money at lower prices. The logic says that a gold price below the cost of production would curtail supply, and the forces of supply and demand would drive the price back to a “profitable” level for gold producers.
We’re sceptical about that argument for commodities generally as we have seen many commodities trade below the cost of production throughout history. We are especially sceptical in the case of gold. Most of the gold that has ever been mined now sits in investors’ vaults, and there is nothing preventing those investors from selling it. If they decide for whatever reason to sell, then it can become part of the supply equation, and the marginal cost to remove it from the vaults is close to zero.
In fact, it may well be that the cause and effect relationship runs the opposite way for gold prices. It seems very plausible that a high price would prompt marginal gold mines to start operating and thereby raise average production costs, rather than the gold price being set by the level at which the world’s gold producers can operate profitably.
So we are left with the current market price as our most reliable indication of what gold is worth, and the question we are interested in is: based on that gold price, are there gold companies whose share prices now look cheap based on our best estimate of the potential future profits, and having regard to the risk?
That debate still has some way to run at Montgomery, but we do have a good idea of where we are most likely to find a positive answer. Some of the companies that we will be running our analysis over include: Silver Lake Resources (SLR), Medusa Mining (MML) and Resolute (RSG).
This article was written on 24 July 2013. All share and other prices and movements in prices are to this date.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
