Since 2020, the gold sector is picking up steam. Despite the fluctuations in the price of gold, some very interesting things are happening below the surface… It’s time to take action!
The 15th edition of the report In Gold We Trust was released on May 27. Every year, Ronald Peter Stöferle and Mark J. Valek (S&V) provide us with their analysis of the world of finance, in particular the price of gold and the price of mining companies.
This industry occupies a very special place in this latest edition since it is not one chapter that S&V dedicates to it as usual, but three! Here is the program :
– the traditional analysis of developments in the mining sector over the past 12 months and commentary on its valuation (27 pages this year!);
– 13 pages devoted to a study devoted to the “predictable” relationship between mining stocks and real interest rates;
– a presentation of the Chinese mining sector (8 pages).
Almost fifty pages therefore, the drafting of which was possible in the light of the more than 120 meetings of the mining sector in which the Incrementum team has participated since the publication of the IGWT 2020 report!
Today, I suggest you give you back the substantive core of the first two subjects of this theme.
Before we start, however …
… It does not seem useless to come back in a few words on the synthesis that I had written last year on the point of view of the two analysts of Incrementum AG on mining. If you have a good memory, you may remember that at the time, this sector came finally to lift the tip of their nose.
In a few words, S&V confirmed in their 2020 report what they have been hammering since May 2019, namely that mining has indeed entered a new bull market, and not just any one.
Indeed, while they expected a price of gold that will rise at least at around $ 4,800 per ounce by December 2029 (this is their “conservative” scenario), the two Austrians saw the mining sector last year as “potentially the opportunity of a lifetime”.
They added that if “the party [avait] start “, we were still far from entering the phase of price acceleration, since mining juniors have continued to underperform the rest of the market since 2017. We could not therefore conclude that “the appetite for risk [avait…] really taken over ”.
Is the situation different this year?
Mining: 12 months of roller coaster
Last year, I recapped the previous episodes in these terms:
“After the big bull market that prevailed between 2001 and 2011, the mining companies experienced a long descent into hell between 2011 and January 2016, before rebounding during the first half of 2016 and then falling again until the bottom of September 2018 Since then, their valuation has almost doubled. “
On the sole level of market valuation, there is not much to add other than to specify that the mining sector continued its ascent until early August 2020, to then consolidate between the level reached around this time and the low of February 2021.
How to interpret this consolidation?
For S&V, “interest in the mining sector has increased significantly over the past year, probably […] due to Warren Buffett’s investment in Barrick Gold, before stabilizing again since ”.
LAnalysts at Incrementum are referring to the somewhat surprising $ 500 million investment made by Berkshire Hathaway in the Canadian company … before the Oracle of Omaha liquidated its position in the fourth quarter of 2020.
Having stopped their figures in May, S&V note that “the HUI is currently trading at the same level as in 2016, so the price per ounce averaged $ 1,350. The additional $ 500 / ounce has translated into a significant increase in the margins and cash flow “of companies in the sector.
In addition, given the recovery in the valuation of the mining sector (GDX) compared to technology stocks (QQQ), S&V evoke “a sector rotation [qui semble] in progress, slowly but surely ”.
This timid rebiquette is not the only argument that S&V invokes to justify their bet. The slight increase in the relative strength of juniors (GDXJ) compared to seniors (GDX) since 2020 shows for them a resurgence, albeit slow, in risk appetite in this sector.
In short, “the value proposition of the mining sector is recognized,” say S&V. All that the sector lacks to shine is “a little love”!
And for good reason…
Mining: “the gold industry is in better shape than ever”
A year after S&V’s portrait of mining companies in their previous report, they say:
“We can say that the sector has kept its promises. The mining value proposition has only gotten better. Much of what was said in the previous edition about mining stocks is still relevant today.
The most significant change concerns the disconnection of the valuations of these stocks from the cash flow of companies in the sector. Notable undervaluations have gone largely unnoticed, with investors focusing on cryptoassets, PSPCs, same stocks like GameStop and, of course, the FAANGs. “
As for the said promises, I refer the reader to my post from last year.
Regarding the achievements, S&V underline that in 2020:
“Producers had the most profitable year in their history. The price spot Gold’s average rose to $ 1,770 an ounce, but the industry average AISC – which represents the cost of mining – remained stable. “
As for the restructuring of the sector through mergers and acquisitions, a major theme of 2019, it has certainly been delayed for obvious reasons, but it remains a certain horizon. In particular, S&V expect a temporary “peak in gold production” which “will increase the pressure to continue with mergers and acquisitions” in order to secure future production.
Let us offer ourselves the luxury of details through a few graphics.
First of all, not only has the sector’s net debt been in free fall since 2014 (the increase in 2020 is obviously due to confinements, but we can see that the yellow curve has almost already reached its pre-pandemic level) …
… But the level of indebtedness of the mining companies is very limited compared to the other sectors of the Russell 3000 (the index which represents the 3000 largest companies listed on the American markets).
This deleveraging This is explained in particular by the evolution of the available cash flow of mining companies, which has reached levels never seen in this sector over the past 25 years:
So the McKinsey firm writes about the mining industry as a whole that “leverage ratios should continue to decline significantly, which will lead to much healthier balance sheets in the near future.”
Not to spoil anything, “the leverage ratios of the gold industry should be significantly better than those of most other mining industries,” say its analysts.
Finally, the return on equity of companies in the sector is at a record level, “which is logical given the record margins achieved on AISC in 2020”, as S&V noted.
The AISC only increased by 1.8% in 2020, while at the same time the ounce gained around 24%.
That’s enough to expect greedy dividend distributions, isn’t it? After long years of moderation, they have been on the rise since… the end of 2020!
Let’s summarize: in 2020, the mining sector found itself with an “industry in better shape than ever”, an average price of gold higher than it has ever been, and yet with a valuation ” at the same level as in 2016, then the price per ounce averaged $ 1,350 ”!
In a future article, we will try to see how to explain this disconnection between fundamentals and prices …
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