Charles Gibson speaks at Charles Russell Speechlys breakfast seminar
Date: 16 Jun 2016
Charles Gibson, mining analyst at Edison, presented at a breakfast seminar hosted at Charles Russell Speechlys, exploring the current gold price cycle. The subject of mining commodity prices could hardly have been a more topical issue, as the front page of City AM heralded a rally in the sector on the morning of the seminar.
The mining sector has faced a torrid few years, particularly following its ‘super-cycle’ slump in 2011, yet gold has been the outstanding performer in recent months and the strongest performer in metal prices over the past 14 years. However, notwithstanding its performance, many analysts and fund managers remain transfixed by the experience of 1980 when, after a similar bull run, gold then entered a 21-year bear market.
Were the same to be true in this cycle, gold’s relationship to inflation and general prices would suggest a price today of around US$1,033/oz. However, given that the gold price since 1959 has always been closely correlated with the US total monetary base (ie the circulation of money and US federal bank reserves) and that if that relationship is to be maintained at a time when quantitative easing has increased the total US monetary base fivefold, then gold should be no less than US$1,246/oz and, not unreasonably, as high as US$1,682/oz.
Part of the reason for the discrepancy is that there has been a complete breakdown of the previously near-perfect relationship between the monetary base and inflation. Nevertheless, it would also seem to be the case that there still exists a post-2007 hangover from the previous methods of gold valuation.
Relating the gold price to the price of gold stocks, Charles Gibson explains: “the problem with the market currently is that it often misprices the risk factors involved in gold mining”. During the period, 2007-16, the market appeared to incorrectly value the risk involved in transitioning from exploration to production, in particular, which resulted in an extreme skew in investment returns, which in turn rendered asset allocation in the sector among the most challenging in the market.
Among the explorers, by contrast, up to 90% of their valuation can be attributed to ‘sentiment’ related to the direction of gold price movement, rather than the actual level of the gold price itself. Nevertheless, the improvement in market conditions in recent months has increased the valuation of resources to the point at which greenfield exploration can yield a return to investors that is once again attractive.
As well as the opportunity created by the break between the correlation of the monetary base with prices and inflation, companies also need to be aware of the sensitivity of the market to changes in the perception of risk and the extent to which this can affect their share prices. As such, companies need to persuade investors to focus on their fundamentals – their management structures, their mining capabilities etc, rather than old benchmarks.
A lack of media consensus on the value of gold and gold stocks has done little to aid gold companies. What was certainly evident from the seminar is that gold stocks remain an attractive investment and we expect that they are set to become an increasingly attractive option for investors to take advantage of in the years to come.
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