Why are Gold Miners Performing So Poorly?

[caption id="" align="alignright" width="120" caption="Robert Sinn"]Bobby Sinn[/caption]

by Robert Sinn, The Stock Sage

While the broader equity market has surged higher throughout 2012 the gold mining sector ($GDX $GDXJ) has been left out in the cold – why the significant underperformance? There are a few are fairly obvious explanations such as weakness in the gold price of late, meanwhile, there are some investor concerns which are somewhat more subtle such as lack of reserve growth and rising costs across the industry. I will try to enumerate the primary concerns currently weighing on the precious metals mining sector in order of importance:

  • Reserve replacement and production growth challenges combined with rising costs and continued operational challenges across much of the industry

  • A paradigm shift among many investors who are now pricing in flat to lower metals prices going forward as opposed to previous forecasts of rising prices. This is mainly due to the current consensus view that Fed tightening is likely to come about sooner than late 2014 and odds of an additional round of quantitative easing have declined in recent weeks.

  • As miners encounter lower grade ore bodies the industry has struggled to maintain production levels – Gregor Macdonald posited the concept of “peak gold” a few weeks ago while highlighting the following chart to demonstrate that despite huge incentives in the form of strong prices gold production has barely budged over the last decade:


  • Similar to large integrated oil companies who have been faced with the potential of “peak oil” and declining reserve growth for many years the largest gold miners are being punished with severe multiple contraction ( the average forward P/E among the top 10 largest gold miners is below 10)

  • Fears surrounding a China hard landing and further tightening to stem inflation in India has hurt the natural resources space as a whole in recent weeks.

Once one has outlined the bear case it becomes easier to determine the veracity of a bullish case. The key determinant of any bull/bear case on the gold miners will ultimately rest largely on the future course of the gold price, however, there will be a few key factors which will serve to separate the winners from the losers among gold mining investors in coming years:

  • Operational efficiency along with a top tier management team who meet or exceed their cost and production targets.

  • Identifying potential future acquisition targets which will be snapped by the majors as they seek to replace reserves and gain larger economies of scale – the recent sector-wide decline in valuations increases the likelihood of some consolidation within the sector over the coming months.

  • The key factors in identifying the quality and attractiveness of a mine: Size, ore grades (which ties into extraction cost), expected mine life, and location.

Finally, for an excellent example of the valuation gap between a large cap gold miner with consistent reserve growth and cost containment and ones that have consistently fallen short on many metrics such as costs, production targets, and reserve replacement look no further than the performance gap between Yamana (AUY) vs. Barrick (ABX) and Newmont (NEM) over the last 200 days: