Invest in Gold and Silver Shares
In 2012 only a few sectors will experience a combination of high sales growth, rising margins, and earnings growth. The gold sector will definitely be among those.
On this basis we compiled a basket of goldmining shares (ISIN: AT0000A0DY51), which contains companies that should benefit particularly from this development. At the moment the following shares are in the basket (N.B. the new company selection and rebalancing is due at the end of July).
Since its issue in July 2009 our basket has almost doubled in value and has thus outperformed all benchmarks:
Performance: Erste Goldmining-Basket
Our analysis shows that the companies relying on organic growth (i.e. on exploration rather than acquisition) were clear outperformers and generated a substantially higher ROCE. The number of shares outstanding in the sector has doubled since 2005. This massive dilution – as well as the emergence of ETF’s – is a reason for the disappointing performance of the sector. Production per share has been on a gradual decline as well, from 2.4 in 2003 to 1.2 at the moment.
As already said in earlier Gold Reports, the consolidation of the gold sector should continue. The effects of the financial crisis were still felt in 2009. Although acquisition volume was substantially up at USD 7bn in comparison with the year 2000, it still only reached one third of the high in 2006. Among the biggest acquisitions were the takeovers of Comaplex by Agnico Eagle, Brett Resources by Osisko Mining, Underworld by Kinross, and Moto Gold Mines by Randgold and AngloGold Ashanti. 28% of all takeovers happened in Africa, 18% in Latin America, 18% in Asia, 15% in Australia, 14% in Europe, and 7% in North America.
The long-term analysis of M&A activities reveals that the most attractive take-over targets were companies with market capitalization between USD 200 and 500mn. The median of the past ten years is USD 140mn, the average USD 280mn. Whereas the focus used to be on producing companies in previous years, it has now shifted to companies in the development phase. On average, premiums were 32% with a clear tendency towards higher premiums recently.
The pressure on the companies is enormous. Barrick Gold for example has to replace almost 8mn ounces in reserves every year. Since extraction is never 100%, the company has to discover 10mn ounces every year. We expect consolidation to continue. The end of the cycle should see an increasing numbers of majors getting taken over as well.
The style analysis shows what fundamental and technical factors have a significant bearing on the price performance of gold mining shares. We formed a basic population of 153 shares and analyzed their performance over a duration of ten years. For the model we sorted the companies by 34 different factors and contrasted them with their respective monthly performance. Then we subtracted the average performance of the lowest quantile (20%) for every factor from the performance of the highest quantile (80%). The difference explains the magnitude of the relative performance of the lowest-valued shares for example on a PE basis in comparison with the shares with the highest valuations in a specific month. However, when considering this ten-year analysis one has to bear in mind that a certain survivor ship bias (bankruptcies) cannot be ruled out.
We have found three significant long-term trends in our population of gold shares: shares with high volatility (risk), low market capitalization (size), and low price momentum were clear out-performers. Or in other words: the risk of investing in small gold mining companies with an up to that point weak performance and high volatility has rewarded investors in the past ten years with an above-average performance.
In contrast to the situation in classic equity indices, factors such as valuation, growth, earnings estimate momentum and even profitability of the companies have had no significant influence on the share price performance in the past ten years. Only high sales growth has had a somewhat positive effect on the performance since 2006. The recommendations by primary analysts on the other hand (both buy and sell as well as target price upside) were well worth disregarding and even ended up recording a small under-performance. With the exception of 2008 and 2009 it was also beneficial to hold shares that were recording an above-average increase in volumes (i.e. liquidity).
The estimated PE for the gold and silver producers in the Gold Bugs index amounts to 26x on the basis of 2010 results, and is expected to fall to 20x by 2013. This suggests that the market is by no means harboring euphoric expectations.
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