Asian investors, including central banks, have been buying bullion recently taking advantage of lower prices. Since the beginning of this year, Exchange Traded Funds, the main instrument for financial investors to gain exposure to gold, have been growing again.
A small change in sentiment in favour of gold can cause disproportionate moves in its price. In view of the sharp fall in its price during the last two years, it should be expected that volatility is likely to remain high.
Performance of gold and gold miners over 2yrs
Source: FE Analytics
From January to mid-March gold rallied by 15 per cent but subsequently tailed-off and retreated to a 10 per cent gain for the year to 10 April [in USD].
Performance of gold and gold miners in 2014 in GBP
Source: FE Analytics
Gold equities, as represented by the FTSE Gold Mines Index, rose significantly more recording a 24 per cent gain by mid-March that, in similar fashion to the metal, retraced to currently stand 12 per cent up year to date.
Smaller capitalisation shares have, in general, been twice more volatile and have outperformed both the index and the metal.
Whilst the behaviour of shares in relation to their market capitalisation and the underlying commodity is expected, the high volatility is likely to keep the generalist investors away.
In a bottoming-out process, such as the one we believe is currently in progress, shares usually attract short-term speculators that are likely to sell at the first sign of slowing momentum.
Nevertheless, since the beginning of the year we have seen a large increase in capital raising activity, mostly undertaken by smaller companies that had been drawing down on their reserves during the bear-market.
By its nature, significant capital raises are funded by specialist sector investors with a medium-term view.
This activity strengthens the balance sheets of companies that have been cutting back on expenses drastically to survive in a lower gold price environment improving their sustainability should gold fall again.
However, there are two important factors distinguishing current optimism: (i) specialist investors direct their funding to the healthier companies with projects that are economically viable on conservative expectations and (ii) only small, low risk exploration programmes, focusing on expanding the reserves and mine life of advanced projects is acceptable.
The bull-market days when prospectors secured a licence area and presented blue-sky exploration potential on the back of scant evidence are over.
Until such time when gold enters into the next phase of its development as store of value and exceeds previous highs, early stage investments should be avoided. In today’s market, near-term cash flow is paramount.
We believe that the companies best positioned to capitalise on a general change in sentiment towards gold mining companies are those with projects located in safe political territories, organic growth in production driving operating costs lower, large reserves that could add to mine life and production growth and a strong balance sheet affording sustainability in a lower price environment.
A core holding in the Junior Gold fund is Endeavour Mining (EDV.TO). It is a Canadian listed gold producer that is exclusively focused in West Africa.
Since 2008, Endeavour has grown from a merchant bank to an owner and operator of four mines that are expected to produce 417.3koz at All-in Sustaining Cost (AISC) of USD 994/oz, in 2014 on a 100 per cent ownership basis.
Additionally, by 2017 we see the Company growing its production profile to 646koz while costs continue to drop.
A very experienced management team is likely to meet the stated targets. Companies like Endeavour have a high operational leverage on the gold price albeit with a structure that is resilient to prolonged market weakness.
Other, similar core holdings of Junior Gold include Kirkland Lake Gold (KGI.TO) and Kingsrose Mining (KRM.ASX).
Performance of stock vs sector over 1yr
Source: FE Analytics
We expect that, with further confidence in the gold price building, longer-term investors are likely to favour this type of company and help their re-rating.
Angelos Damaskos manages the MFM Junior Gold fund. The views expressed here are his own.
