Barrick Gold Corp. (ABX) and Goldcorp Inc. (G), the world’s largest producers of the metal, are poised to outperform bullion after gold-mining companies fell to their cheapest in at least a decade, executives said.
Gold producers are heading for an “inflection point” triggering a rally, Barrick Chief Executive Officer Aaron Regent said in an interview. They have been punished as investors decided the shares should no longer trade as a proxy for physical gold, he said.
The growing popularity of gold-backed exchange traded funds, or ETFs, which include the $73.3 billion SPDR Gold Trust, probably have taken away some of the capital that previously was invested in companies such as Toronto-based Barrick, Regent said. Investors have shunned gold producers choosing instead to hold physical metal and ETFs after gold prices advanced in 11 successive years and touched a record in September.
The NYSE Arca Gold BUGS Index (HUI), which includes Barrick and 16 of its competitors, has advanced 53 percent in the past five years while spot gold traded in London has more than doubled. The index trades at about 17 times earnings, compared with an average of 65 over the past 10 years. The ratio fell to a decade low of 15 on Jan. 20.
“There will be a point where the multiples just converge with every other company,” Regent said Feb. 16 at Bloomberg News’s Toronto bureau. “Then you will start to see potentially increased leverage in the share price versus a gold price move.”
‘Investors Puzzled’
Holdings (.GLDTONS) of physical gold via ETFs have more than tripled in the last five years to 2,390 metric tons, an amount valued at about $137 billion, according to data compiled by Bloomberg. While such funds seek to track the price of gold, shareholders of gold producers may suffer the effects of mining accidents, cost overruns or asset writedowns.
Gold ETFs have “been a huge hoover of capital and competition for the gold companies,” Peter Miller, BMO Capital Markets’ head of equity capital markets in Canada, said in a Feb. 17 telephone interview. “It’s easy just to park yourself with an ETF versus taking on the capex creep and the operational risk of some of these development plays.”
Paulson & Co., the $23 billion hedge fund founded by John Paulson, said in its year-end letter that “investors remain puzzled” by gold stocks’ underperformance relative to gold. One likely explanation is concern that gold prices may decline, said Paulson, which is bullish on the metal.
Currency-Devaluation Play
Quantitative easing in the U.S. and other countries will lead to inflation, spurring more demand for gold as a hedge, the fund said in the letter, which was obtained by Bloomberg News. New York-based Paulson invests in the SPDR Gold Trust (GLD) as well as mining companies. The fund owned 12 percent of South Africa’s AngloGold Ashanti Ltd. (ANG) as of May 30 and 8.3 percent of Vancouver-based NovaGold Resources Inc. (NG) at Dec. 31, according to data compiled by Bloomberg.
Gold for immediate delivery gained 0.2 percent to $1,780.07 an ounce by 9:40 a.m. in London. It’s up 14 percent this year and reached a record $1,921.15 on Sept. 6.
While declining to give a specific estimate, Regent said he expects gold prices will surpass last year’s record.
“If fiat currencies continue to be devalued and gold just holds its value, on a relative basis it’s going to go up,” he said.
Rising Costs
Another reason for producers’ underperformance is that they’re valued by analysts and investors who assume a long-term gold price of about $1,300 an ounce, he said. Gold will average $1,798 in 2012 and $1,975 in 2013, according to the average of analysts’ estimates compiled by Bloomberg.
“There’s quite a significant gap between how the world’s traders see the gold price and how equity analysts, with their conservative forecasts, are looking at it,” Tye Burt, CEO of Kinross Gold Corp. (K), Canada’s third-largest producer, said in a Feb. 15 interview.
While investors are concerned that rising production costs in the industry will squeeze profit margins, gold-mining equities will “ultimately outperform, given the leverage in gold producers relative to the gold price,” Burt said.
Barrick, Kinross and Canada’s Goldcorp all forecast mining costs will increase in 2012 as labor, raw-material and equipment expenses keep rising. Another factor boosting costs is producers’ extraction of lower-grade ore that wouldn’t have been profitable when gold was cheaper, Regent said.
Dividend Increases
Gold producers’ valuations will be helped by higher dividend yields, said Sean Boyd, CEO of Toronto-based Agnico- Eagle Mines Ltd.
“We really need to attract a broader range of investors,” Boyd said in a Feb. 16 interview. “I think the industry can capture those investors if it shows discipline around capital spending and paying a bigger dividend yield.”
Agnico and Kinross said Feb. 15 they will increase their payouts to investors. Barrick, Goldcorp and AngloGold have also announced dividend increases in the past year. Newmont Mining Corp. (NEM), the second-biggest gold miner by sales, said yesterday it’s more than doubling its quarterly dividend, 10 months after announcing it would link payments to the gold price.
Such payouts are becoming increasingly important for gold miners, Donald Coxe, a Bank of Montreal strategy adviser, said in a Feb. 21 interview.
Premium Eroded
“While they’re waiting for the market to recognize the intrinsic value of these wonderful corporations, why don’t you pay them some money?” he said.
Still, even if gold producers outperform the metal, they may never fully recapture their old valuations, said David Christensen, CEO of ASA Ltd. in San Mateo, California, which manages $600 million.
“The ‘traditional’ premium has probably flown the coup,” Christensen said by e-mail. “There are just too many alternatives to buying gold shares today, such as ETF products, that have eroded the premium multiples.”
Barrick said Feb. 16 its fourth-quarter net income was little changed at $959 million. Sales advanced 26 percent to $3.79 billion, outpacing its so-called total cash costs, which rose 15 percent to $505 an ounce. Gold, which has gained for 11 straight years, averaged $1,687 an ounce in the fourth-quarter in New York, 23 percent more than a year earlier.
Goldcorp, the world’s second-largest producer by market value, has seen its cash flow more than double in the last three years, CEO Chuck Jeannes said in a Feb. 15 interview. The shares have risen 23 percent in the same period.
“That I don’t think is a sustainable trend,” Jeannes said. “At some point we become so inexpensive on a cash flow per share multiple that it makes no sense for buyers not to acquire the stock.”
