Gregson: Gold equities on the brink of a rebound
The manager of JPM Natural Resources says the industry is responding to its challenges and stock prices will soon rise.
Gold equities' recent poor run is coming to an end, according to Neil Gregson
, lead manager of the JPM Natural Resources
and JPM Global Mining
He claims gold stocks have de-rated after a period of over-inflation during the 1990s, but are now ready for a more meaningful rally.
"There is no denying that the performance of gold equities has been disappointing, to say the least, relative to physical gold prices over the past few years," he said.
"The performance divergence has been particularly prominent since the beginning of 2011 and this trend seems to be continuing in 2012."
"While we accept that gold shares are unlikely to regain the valuation premiums enjoyed in the past, simply because the industry is currently in a very different cycle, we do believe that the devaluation relative to gold spot prices has largely run its course," he added.
Gregson explains that many gold mining companies are trading at 0.7 to 0.8 times their underlying net asset value (NAV), with valuations discounting an equivalent of $1,200 per ounce of bullion versus the current spot price of around $1,500-1,600 per ounce.
This means gold equities are trading at depressed levels, but a major efficiency drive within the industry could soon cause this to change.
Mining giant Rio Tinto, which digs for gold and silver among other minerals, is the top holding in both JPM Natural Resources and JPM Global Mining, of which it made up 10 per cent in March.
Gregson took over the £2bn JPM Natural Resources portfolio from industry icon Ian Henderson in January this year.
The mining fund has had a poor five years, losing 29.71 per cent while its HSBC Global Mining benchmark is down 36.36 per cent.
Performance of fund vs benchmark
Source: FE Analytics
JPM Natural Resources has done better in this period, losing just 3.29 per cent. However, its HSBC Global Mining and Energy benchmark rose by 58.86 per cent during this time.
A historical examination of gold equity prices relative to physical gold forms the basis of Gregson’s undervaluation argument.
"In the 1960s and 1970s most of the listed gold equities were the South African producers and tended to be valued on dividend yields," he said.
He explains that in the 1980s, valuations increased as investors paid a growth multiple and a premium for exposure to gold price movements.
"Direct investment in gold was either not allowed under investment guidelines or was not practical and gold ETFs did not even exist at that time," he continued.
"As a result, valuations of gold mining companies trended increasingly higher through the early 1990s, and gold shares, on average, traded at two-to-three times the value metrics of the other mining companies."
"A lot of gold companies also started to hedge a significant proportion of their gold production."
"However, as gold prices rose consistently from 2001 onwards, a number of gold companies ended up realising gold prices lower than spot prices, or spending money to close out hedges that had upset shareholders."
This, added to slow growth in production and a sharp increase in overheads, meant exchange traded funds (ETFs) became popular as an alternative to gold equities.
However, Gregson believes the industry is responding to this challenge.
"In our view, gold equities are trading at depressed levels and the industry is recognising the importance of better capital discipline, cost control and paying increasing dividends to compete with gold ETFs. As such we believe investors should not give up on gold stocks," he finished.