Thematic Investments: Gold Miners
Free Cash Flows Expansion: Gold Price Appreciation Outpacing Capital & Op. Costs


Investment Rationale
  • Amid the ongoing Euro Zone debt crisis, rising concerns over the U.S. debt and on-going quantitative easing policies, gold has traded near record highs; however, gold stocks have traded sideways. We believe this disconnect can be attributed to concerns over rising operating and capital costs and doubts over the sustainability of the gold price over the long term. We acknowledge that cost inflation has once again become an issue for gold miners; however, in the current environment, the gold price gains have more than offset this impact. 
    • We forecast significant cash flow generation and margin expansion over the next 12-24 months as the gold price is driven higher and supported by geopolitical concerns, while a slowing global economy could slow the recent cost escalation.

  • Historically, margins in the gold industry have always been relatively thin until the gold price started to rally in 2006. Over the last five years we have seen steady margin growth; and while free cash flow has been improving and dividends have grown, while the high capital demands of gold mining limited the value creation:
    • Margin expansion: We are positive on the gold price over the next 12-24 months based on concerns over sovereign debt, continued low real rates into 2016, strong physical demand in India and China, and central bank buying. Meanwhile a lackluster global economy could keep input costs relatively stable. Still, oil prices are highly correlated with cash costs for gold miners, and a significant near-term move higher in the oil price is possible given current geopolitical concerns.
      • Based on current spot prices of approximately $1,300/oz and current oil prices of about $105/bbl, we could see margins of roughly $350/oz. To put this in perspective, many recently completed and proposed mines were deemed to be economic at a gold price of $800-$1,100/oz with margins of $150- $350/oz.
    • We estimate that gold stocks are pricing in a long-term gold price of $1,350/oz. If the gold price remains elevated and/or investors accept a higher long-term gold price we could see 20-25% upside in the equities.
  • We recommend investors focus on large to mid-cap gold producers that have recently rationalized their operations. Our analysis suggests ABX and GG have the best FCF profiles in the next 12-24 months.
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The place of Gold in an Asset Allocation by Claude B. Erb & Campbell R. Harvey.  1606k v. 7 Nov 24, 2013, 3:00 AM QMS Advisors