Margin trumps ounces as gold miners shine despite COVID-19
Comment of the Day

September 04 2020

Commentary by Eoin Treacy

Margin trumps ounces as gold miners shine despite COVID-19

Thanks to a couple of different subscribers for this note from BakerSteel which may be of interest. Here is a section:

Eoin Treacy's view

Here is a link to the full report and here is a section from it: 

As active investors, shareholder returns policies are a core focus for Baker Steel’s team. Yield analysis is a key element of our value-driven investment process. Through bottom-up quantitative research using our proprietary GenVal system, coupled with analysis of revenue multiples, yield potential and other tools our team have delivered consistently superior risk-adjusted returns relative to our peers and passive investments in the precious metals sector.

A renewed focus on dividends is a significant trend for gold equities, particularly at a time when yields are falling in other sectors. The capacity for further dividends increases, as margins expand, is a key driver for the sector’s re-rating potential in the months and years ahead.

A true stand-out company has been Kirkland Lake, which is the largest holding in BAKERSTEEL Precious Metals Fund (“the Fund”) at the time of writing. The company returns money to shareholders via both a dividend and share buybacks and just reported the following:

If we combine the amount of cash used for share repurchases and dividend payments in the first half of 2020, it represents approximately USD645 per ounce of gold produced during the period. Tony Makuch, CEO, Kirkland Lake Gold

The significance of this statement, which may take a few moments to sink in, is to confirm that USD645/oz of production has been returned to shareholders in some form. In this simple and easy to understand metric Kirkland has succinctly communicated that the company’s margins are substantial and sustainable, and that the company’s balance sheet is strong enough to produce this type of return.

Value propositions have not been popular among investors who have had the pleasure of instant gratification in growth stocks for much of the last decade. A catalyst is required to spur interest and that is being delivered in the form of anxiety about the ramifications of the response to the coronavirus.

Gold and silver have now completed their base formations. The logical next step for traders is to favour leveraged plays on the metal. Gold stocks, where there is clear visibility on the cost of production and willingness of management to reward shareholders, represent a very attractive proposition for medium to long-term investors.

The number of companies that are both increasing dividends and have a competitive absolute yield is quite limited following and has declined during the pandemic. That opens up the gold mining sector to whole swathe of income-hungry investors. Warren Buffett‘s purchase of Barrick will be viewed as almost a royal imprimatur for the sector. 

Kirkland Lake has been an impressive performer but it will probably need to engage in M&A to replace reserves. The company has been increasing its share of Osisko Mining suggesting the potential for a full takeover at some stage. Kirkland’s share is currently pausing in the region of the 2019 peak. Osisko Mining remains in a seven-year base formation.

The challenge for institutional investors looking to take positions in the precious metals miners is the market cap of the sector is comparatively small. The combined market cap of all US domiciled gold miners is $70.5 billion. For Canada it’s $242 billion, Australia’s is $58.7 billion and the UK’s is $26 billion. That means the precious metals mining sector has about the same market cap as Johnson & Johnson.

Institutions take on a great deal of single stock risk by buying gold shares which means they tend to favour ETFs. The other side of the argument is the size of the market relative to the available capital for investing holds out potential for a significant rerating of the sector.

I am seeing increasing news of institutions allocating to gold. For example, the $15.6 billion Ohio Police & Fire pension fund announced a 5% allocation to gold last week. I have been waiting for a pullback to buy back my trading positions in gold and silver. The weight of institutional money coming into the sector has so far supported prices despite pullbacks in other risk assets.

Back to top

You need to be logged in to comment.

New members registration