Gold’s breakout heralds boost for smaller producers as seniors lumber behind

TORONTO (miningweekly.com) – Gold’s run so far this year might have surprised several analysts, specifically those who had predicted an annus horribilis for the yellow metal starting mid-2015.

Gold certainly came under some pressure towards the end of 2015, hitting a calendar-year low of $1 049.40/oz London pm fix on December 17.

The US dollar was riding high, discussions about growth rates abounded and, on December 16, there was a small increase in US interest rates – the first move upwards in several years and taken by many as a sign of better times ahead.

But gold fought a rearguard action and then managed to breach the $1 100 barrier several times in January. The recent breakout started at $1 106.60/oz on January 25, reaching $1 241/oz on February 11, an increase of 12.15%.

It has since retrenched, standing $1 210.10/oz London pm fix on Thursday.

SAFETY FIRST
Several dynamics were at play, dominated by money seeking gold’s safe-haven status on economic concerns, particularly those related to the US.

“Those of us who watch the markets closely have been worried about the US economy for some time, certainly in relation to overvaluation,” newsletter writer and founder of Resource Maven Gwen Preston told Mining Weekly Online.
 
US manufacturing performance had been decidedly middling recently. For example, the Institute for Supply Management’s manufacturing index stood at 48.2% for January, up from 48% in December 2015.

The US Federal Reserve noted that manufacturing output increased 0.5% in January, up 1.2% year-on-year. These were hardly figures to set the pulse racing.

Even though it only makes up just over 10% of US gross domestic product, manufacturing was important because of its direct-indirect employment levels and the value associated with that.

Auto sales, another economic indicator, also dipped in January. For example, 486 245 new passenger cars were sold across the US, as opposed to 529 696 in January 2015, according to Motor Intelligence data. 

“There are big question marks surrounding vehicle sales,” Preston said. “They were really hot for 2014 and 2015 largely because of what I would call sketchy loans that are now diminishing.”

Investing in US blue chips had also tapered as the six-year bull-run in overall equities came to a close. Money looked elsewhere for value and select gold producers stood out.

“Gold miners have the double appeal of granting safe-haven exposure and the knowledge they are undervalued,” Preston said. “In that sense they become a two-in-one package.”

MORE ON THE FLOOR
Whether the rally embedded a tangible uptrend remained to be seen, although a floor of $1 200/oz to $1 210/oz appeared established. Still, further corrections and volatility was expected, with market participants hoping for higher highs and shallower lows.

“Any time a trend changes it will have step-ups and corrections,” Preston noted.

The benefits of gold’s improved lustre could percolate into gold-related equities. However, the classic tiered effect – seniors feeling the boost first, followed by midtiers, juniors and explorers – might not occur as it had in the past.

Several seniors could be avoided as investors argue their strategies during the resource supercycle delivered overpriced acquisitions and failed to create sufficient value for the companies or shareholders.

“That’s the shadow that tarnishes majors a bit,” Preston said, noting that midtiers with fair balance sheets and strong projects on their books had much less damage to fix.

Seniors also needed to service and retrench large debt loads, affecting their upside potential and the returns investors could make on this. On the other hand, smaller companies with better-looking balance sheets avoided the issue of debt weighing on performance.

The issue of high grading was problematic as well. Many seniors had been mining their best ore to maintain margins and pad balance books for short-term relief or gains.

But that meant exploiting a mine’s most valuable ore more quickly. “It also means sterilising chunks of resources as the lower-grade portions of a deposit are left behind and become uneconomic to mine,” said Preston.

High-grading could produce an inadvertent, long-term advantage for explorers or junior developers. Seniors would be forced to seek out new assets to replenish resources and develop economically viable mines.

Projected declines in the level of gold supplied into the physical market could also assist, although, like high-grading, the effect would only be felt over the longer term.

“I’m interested in supply and demand, and 2016 is probably going to be the first year we’ll see a production decline. Those things matter in the big picture, but at this point there is no lack of gold,” said Preston.

OTHER ISSUES
For the streaming and royalties companies, a tangible upside would act as a signal to push through deals before the upcycle changes their business dynamic of securing advantageous terms during downturns.

“They’re making moves right now. I saw a number that the top three or four royalties and streaming companies put out $3.5-billion in deals in the second half of 2015,” noted Preston.

Meanwhile, exchange-rate differences have favoured smaller producers. “Those with only one or two operations in the right places are getting good exposure here. For example, if you have operations in Canada or Australia then you’ll be getting a fantastic 20% to 30% lift on the exchange rate,” she said.

These producers would also become increasingly attractive as acquisition targets when the market recognised the bottom was in and that the upcycle was nearing.

“Smart money is saying the bottom is in. That means there’s a bit more pressure on the bigger guys to buy the assets they need before they get too expensive,” said Preston.

More money entering the sector and circulating through it would also create a virtuous cycle of more interest and further investment.

The rest of 2016 could be filled with opportunity, albeit with participants having to get used to the ups and downs. “Sometimes the shine will come off and share prices will fall a bit; sometimes things might be a bit more expensive today than a week ago. It’s not going to be a rocket ship to the moon.”