Investors bet miners will follow gold’s gains

Gold has risen 28 per cent to date this year – making it one of the best-performing investments. And yet the share price of Barrick Gold, the world’s largest producer of the precious metal, is trading only 40 cents higher than where it started the year.

Barrick is not alone in its relative underperformance: the S&P/TSX index of global gold mining equities has underperformed the yellow metal by 33 percentage points in the past year – including dividends.

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This divergence between the share prices of miners and the gold price has opened up what is rapidly becoming one of the hottest trades among hedge funds and other asset managers. Increasing numbers are betting that the underperformance of the gold mining sector is unsustainable, making equities ripe for a rapid rally.

“It’s something that everybody is thinking about at the moment,” Evy Hambro, manager of BlackRock’s Gold & General fund, one of the largest gold funds, tells FT.com in a video interview. “A lot of our clients are switching out of the gold ETF [exchange traded fund] into gold equities and gold equity funds to take advantage of the opportunity.”

The disconnect between equities and bullion is a central point of debate at the gold industry’s two largest annual gatherings, both taking place this week – the London Bullion Market Association conference in Montreal, and the Denver Gold Forum. Mr Hambro’s views have been echoed by other large investors, analysts and mining executives.

One argument why gold equities should rebound is historical. Gold mining stocks have enjoyed a strong correlation with the gold price in the past. The current disparity, by this reasoning, is the result of an indiscriminate sell-off across equity markets, and should soon reverse.

“At some point it has to turn,” says Nick Holland, chief executive of Gold Fields, the fourth-largest gold miner. “We’re just at a strange point in the cycle.”

“We’re confident the gap will close,” adds Mr Hambro: “It has always closed in the past. This is an abnormally long one and an abnormally large one.”

However, there have been several structural shifts in the market that could explain the underperformance of the equities.

Investors increasingly buy gold as a form of insurance against further economic turmoil. Mining companies – which can miss production targets, suffer strikes, accidents and higher taxes, or see their profits eroded by cost inflation – appear to offer less reliable protection against such a scenario.

Instead, money has been pouring into ETFs. SPDR Gold Shares, the largest of these, now has $72bn invested in it.

But despite helping to drive the gold rally, many believe ETFs, which were heavily promoted by the gold mining industry, have cannibalised demand for gold equities. Barrick’s shares are trading at less than 10 times next year’s consensus earnings – down from a ratio of more than 30 times only five years ago.

“The guys who created the ETFs are now the losers,” says Peter Munk, chairman and founder of Barrick. “We are now selling at multiples equal to base metals. Today copper guys are laughing at me,” he adds wistfully.

Another reason why equities could continue to underperform is the lack of growth prospects for the industry. While some companies, such as Goldcorp or Yamana Gold, are planning a substantial production increase, the industry as a whole struggles even to maintain production at current levels. Barrick’s acquisition in April of Equinox, a copper mining company, was seen by many as a tacit admission that there were no growth opportunities for the company in gold.

Richard O’Brien, chief executive of Newmont, the second-largest gold miner, concedes that “we could see this kind of derating continue for a while”.

For all that, however, many are still betting that the current disconnect between mining equities and bullion is unsustainable.

For a start, gold miners are beginning to respond to their share-price underperformance. The most popular response is to raise dividends, offering investors one thing ETFs cannot: a yield.

Newmont recently introduced a dividend structure that committed to raising the annual dividend by 20 cents for every $100 rise in the gold price; on Monday, it announced an additional 10 cent increase for every $100 above $2,000. Gold Resource Corporation, a small US-listed miner, said it might start paying dividends in physical gold.

“The industry is conscious of needing to give shareholders more of a direct link to the gold price,” says Mr O’Brien of Newmont. “I think the dividend is the best way to do that.”

Nonetheless, the dividend yield on global gold mining equities remains a puny 0.7 per cent, according to Bloomberg data. That compares to 3 per cent for the FTSE All World index.

“To the extent that we can get dividends up to a meaningful level, that will end up being a distinguishing factor,” says Chuck Jeannes, chief executive of Goldcorp, the fifth-largest gold miner.

If that were to fail to restore the historical balance, then the gold sector could be poised for a series of deals, analysts say.

The equity markets are pricing in a gold price of about $1,400 an ounce, says Patrick Chidley, gold equities analyst at HSBC in New York. But there is a liquid market in gold forwards, meaning miners could guarantee a price above $1,800 an ounce for several years by hedging.

“The obvious conclusion is that private equity will begin to get interested,” says Mr Chidley. “I’ve never seen these stocks this cheap and I don’t think the game is over. That’s what is being priced in at the moment.”