Gold equities among analysts’ top picks to outperform in 2012
Gold prices have risen substantially over the past 10 years, but gold equities haven’t kept up. Shares of gold mining companies have underperformed gold bullion to such an extent that sector P/E and EV/EBITDA ratios are near 20-year lows.
Gold Mining ETFs: Gold equities are among analysts' top picks to outperform in 2012.
Consequently, given the global economic uncertainties, gold equities appear to be among analysts’ top picks to outperform in 2012. Banks including Deutsche Bank, Morgan Stanley and Nomura are all bullish on the sector.
In recent papers, Deutsche Bank said that shares in the mining sector look cheap following a shift in investors’ view of the sector, due to insufficient “tangible returns” and doubts over whether commodity prices will hold up.
Meanwhile, Morgan Stanley said that “gold producers are set to benefit from a resilient gold price” as investors flock to gold as a safe-haven asset.
Nomura, in an initiation of European listed gold producers, also holds a bullish stance on the sector. Their positive view is built on three key premises: that the current gold price is well supported and should continue in the medium term; that the strong gold price will likely result in a period of rapid EBITDA growth and cash build for the miners; and that gold equity valuations are at historical lows.
The Nomura case for gold equities is fleshed out in a bit more detail below:
The current gold price is well supported and should continue to rise in the medium term
Secular Asian demand growth, low and/or negative real interest rates, increasing central bank demand and potential increases in investment sentiment indicate that demand levels will grow. On the supply side, a lack of flexibility in near-term mine supply and a levelling off of scrap gold supply is likely to continue to put upward pressure on the spot gold price.
Nomura analysis suggests that central bank demand has the potential to grow from virtually nothing to nearly half of the level currently seen by jewellery (which accounts for 40% of the market). This, in conjunction with a potential wider shift in asset allocation to gold, could see gold prices de-anchoring from current levels, with significant upside.
Nomura gold price forecasts remain near 2012 consensus at USD 1,788/oz, and slightly above 2013 consensus at USD 2,063/oz. Importantly for the gold equities, Nomura expects the gold price to stay above 2010 levels through 2015 and expects long-term equilibrium prices of USD 1,200/oz.
The strong gold price will likely result in a period of rapid EBITDA growth and cash build for the miners
The aggregate industry EBITDA (based on the DS World Gold Mining Index) is set to reach USD 60bn by 2013 compared with the roughly USD 10bn generated in each of the years between 2006 and 2009. This should translate into increasing cash balances for producers. Nomura expects dividends to grow, new expansion projects to progress and M&A activity to also increase sharply.
Cash heavy balance sheets have important implications for the sector. As seen in the case of Eldorado Gold Corporation’s recent bid for European Goldfields, M&A activity, especially for growth ounces, is likely to increase.
Gold equity valuations are at historical lows
Despite increased profitability and improved balance sheets, gold equities have underperformed gold bullion since 2006 and are trading near 20-year lows in terms of P/E and EV/EBITDA multiples.
Even without recovery in sector multiples, the rapid EBITDA growth to c. USD 60bn a year by 2013E (2011: c. USD 30bn), would imply a significant increase in the enterprise value of gold equities over the next two years.
The producers have failed to participate in the recent gold price rally, with gold increasing by 9% in 2011 as global gold equities fell by c.20%. The global gold P/Es have averaged 23x since 2000, whereas the stocks now trade below a 2012E P/E of 15x, providing space for valuation uplift.
The current sector dividend yield is 1.0% and in recent years a number of companies have announced new dividend policies. Assuming yields remain at current levels, FY13E consensus dividends imply a global market capitalisation approaching USD 500bn or nearly 50% upside potential.
On a P/NAV basis, the average gold stock trades at below 1.0x (at spot gold prices). Nomura calculates an average implied price of USD 1,488/oz. This implies that investors are not yet pricing in the full potential for gold prices to stay stronger for longer.
For investors looking to play this theme there are a number of ETFs to consider (country of listing in brackets):
iShares S&P Commodity Producers Gold ETF (UK)
The iShares S&P Commodity Producers Gold ETF aims to track the performance of the S&P Commodity Producers Gold Index. This index provides exposure to the largest publicly-traded companies involved in the exploration and production of gold and related products from around the world.
ETFX DAXglobal Gold Mining Fund (UK)
The DAXglobal Gold Mining Fund aims to track the performance of the DAXglobal Gold Miners Index. This index gives investors the opportunity to participate in and track the performance of companies operating around the world primarily in the areas of gold mining. The constituents are exclusively companies that generate at least 50% of their income from this sector.
RBS Market Access NYSE Arca Gold BUGS Index ETF (UK)
The RBS Market Access NYSE Arca Gold BUGS Index ETF aims to track the performance of the NYSE Arca Gold BUGS Index. The Gold BUGS (Basket of Un-hedged Gold Stocks) Index is a modified equal weighted index of companies involved in gold mining. The index provides significant exposure to near-term movements in gold prices by including companies that do not hedge their gold production beyond 1.5 years.
ComStage ETF NYSE Arca Gold BUGS (De)
The ComStage ETF NYSE Arca Gold BUGS also tracks the NYSE Arca Gold BUGS Index (see above).
Market Vectors Gold Miners ETF (US)
The Market Vectors Gold Miners ETF seeks to track the performance of NYSE Arca Gold Miners Index, a modified market capitalization-weighted index which provides exposure to companies worldwide involved primarily in gold mining, representing a diversified blend of small-, mid- and large- capitalisation stocks.
Higher risk
Global X Gold Explorers ETF (US)
The Global X Gold Explorers ETF seeks to track the performance of the Solactive Gold Explorers Index. This index offers exposure to the largest and most active companies involved in the search, or exploration, for gold.
Market Vectors Junior Gold Miners ETF (US)
The Market Vectors Gold Miners ETF seeks to track the performance of the Market Vectors Junior Gold Miners Index. This index is more speculative as it offers exposure to smaller -and medium-sized companies operating in the global gold mining industry, so-called ‘junior miners’.
Horizons BetaPro S&P/TSX Global Gold Bull+ ETF (Can)
The Horizons BetaPro S&P/TSX Global Gold Bull+ ETF seeks daily investment performance equal to 200% the daily performance of the S&P/TSX Global Gold Index. This index consists of securities of global gold sector companies listed on the TSX, NYSE, NASDAQ and AMEX.
Direxion Daily Gold Miners Bull 3x Shares ETF (US)
The Daily Gold Miners Bull 3x Shares seeks daily investment results of 300% of the performance of the NYSE Arca GoldMiners Index.