I remember starting life as a young futures broker and listening to a passionate sermon from a seasoned investor who was “long” on gold and fervently trying to convince me that a rally for the precious yellow metal was imminent.
Gold was circa just US$300 (AU$453) per ounce at the time.
Fast forward close to 25 years and I find myself on the other end of the phone preaching the same thematic to anyone who will listen – even though the US dollar gold price is now hauling in more than US$2319 an ounce and the Australian gold price is reaching for the stratosphere at a mark still exceeding $AU3500.
This is partially due to a weak Aussie dollar, but also because of a slow and steady rise in the underlying metal price itself. In the past few months alone, gold in Australia has rallied about 30 per cent from a low of $2861 an ounce in October and that has finally started to awaken gold stock investors who have seen few, if any, big jumps in their share portfolios. The pool of listed producers seems to have shrunk, with the likes of Newcrest Mining and Newmont Corporation merging their global operations, while many of the developers looking to build new mines have been on struggle street when it comes to securing both equity and debt financing.
So, what’s up with that? Why has it been so damn hard to make money as an investor in gold equities at a time when the gold price is going nuts?
The days of the gold explorer betting everything on the rotary lie detector and spending their last cent on a “roll of the dice” while hoping to hit the jackpot, seem a little too distant now. It seems the key role of the junior explorer these days is to make sure it has enough money to stay alive by competing furiously for capital and the fleeting attention of investors who move in a “virtual herd” from one market darling to the next.
As the behaviour of investors continues to evolve by moving away from the whispers of stockbrokers and into the virtual realm of online chatrooms and discount brokerage houses, the plight of the explorer is made all the more challenging – particularly those with deposits that extend to the depths of the earth, but have questionable grades.
During the gold rush in the late 1800s, the pioneers who founded the emerging gold industry had the benefit of an abundance of shallow (and frequently outcropping) deposits with eye-watering grades that were often more than an ounce per tonne (31 grams per tonne). Compare that to the majority of mineable resources today, with grades of 1g/t or 2g/t and we are a long way away from the days of old.
Back in the real world, companies are funding drilling programs to target mineralisation more than 250m below surface, often in extremely difficult or inhospitable locations lacking basic infrastructure and services. It is a little like the dog that chases and catches the car and then doesn’t know what to do with it.
Producers and explorers alike have recently emerged from an environment where labour, fuel and all essential input costs have risen sharply over several years. This high cost-driven inflation amid strong trading conditions has created a scenario where record production and revenues are eroded by higher costs.
Notwithstanding the very real considerations such as cost inputs and production numbers , my genuine belief is that sentiment is the real driver of share prices and performance. It is not enough to have a good deposit, good management, or good timing, companies also need the herd to be riding a tailwind of sentiment – which only comes on the back of bullish conditions capable of increasing a share price and the level of momentum and activity in a sector. Until recently, the sentiment in the gold sector has been poor, with investors focusing purely on the battery metals juggernaut, desperate to get some exposure to commodities such as lithium at the expense of the old faithful, gold.
So where to from here?
Having established some of the challenges and negative forces holding back the sector, the reason we have seen a divergence between the gold price and gold equity prices becomes slightly more obvious. The key question now however is – when do we close the gap?
Valuations for gold stocks are starting to improve, investors are slowly coming to terms with the interest rate-rising cycle and the reality that the process of increasing interest rates has more than likely come to an end. With the eventual reduction in inflation, I expect to see the miners gain some leverage over their costs, which, given the strength in the current gold price, can only result in higher margins and greater profits.
The good news is that high inflationary periods drive miners to operate more efficiently and we end up in a situation whereby the key producers have lagging share prices, but high cash balances and typically low to no debt. It is the perfect storm for M&A (mergers and acquisitions) activity.
Consolidation is the domain of the big boys. At the junior end, investors live off the hope of making a company-transformational discovery, but at the big end of town, size wins! The quickest way to grow the size of a company is through mergers and/or acquisitions, typically where two firms combine to form one bigger one and bank the resultant internal savings from doubled up functions that can now be dispensed.
More recently, we saw the mega-merger between Newcrest and Newmont and on a smaller scale (yet still in the billions), Westgold Resources has struck a deal to merge with TSX-listed Karora Resources – the owner of the high-grade Beta Hunt gold mine in Western Australia.
Given the strength in balance sheets, the lack of debt and the relatively low historic valuations in the sector, the landscape is perfect for greater consolidation and we should see more and more interest in takeovers as the leaders in the sector aggressively look to combine assets, particularly where cost savings can be achieved and production increases (or mine life extensions) can be made.
The greatest consequence of M&A in a sector is investor sentiment. Investors love nothing more than a good takeover (particularly a hostile one) and if we do indeed start to see – as we should – real M&A activity emerging in the beaten-up precious metals sector, positive sentiment will naturally flow into equities. It typically starts with the highest-quality plays and then slowly, but surely makes its way down to the developers and then eventually to the more speculative explorers … the true Aussie battlers working away, one drill hole at a time, hoping to make that company-making discovery!
While the producers can and will take care of themselves, I remain incredibly optimistic about the near-term future for gold explorers and developers. After what has been a long hiatus, the conditions are now perfect for investors to flock back into the sector. As capital becomes more readily available, we see an increase in exploration activity and ultimately discoveries.
For the big producers turning rocks into gold bars every day, the biggest challenge they face is the absolute need to grow their resources, while constantly having to prove to investors that although they are depleting their resources, they can add more through exploration or acquisition.
So, we just might be witnessing the perfect storm for the gold bulls – a strong underlying price, strong balance sheets, efficient operations and the freeing up of capital.
And FINALLY, perhaps, the return of the herd!
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Davide Bosio is the WA State Manager and Director of Corporate Finance at investment and wealth management firm Shaw and Partners. For 22 years he has been immersed in the WA finance industry offering corporate services and strategic advice to private and public organisations, specifically in relation to capital raisings and M&A advice. He has also been to the other side having been a director of multiple ASX-listed public companies. While he is the State Manager of Shaw and Partners (AFSL 236 048) this column is for information and entertainment purposes only and is not intended to constitute financial advice. The views and opinions contained within are those of the author and do not necessarily represent those of Bulls N’ Bears, this media outlet or Shaw and Partners.
By Davide Bosio
