In this day and age, Franklin is looking for gold producers to become better than the commodity they produce. We see four significant opportunities for gold mining companies to redefine themselves as a vital part of a properly diversified investment portfolio.
Gold miner opportunities
- Differentiate themselves from investment in physical gold by showing earnings leverage from higher gold prices supported by a profitable business capable of paying dividends;
- Use their scale and resources to make smart business decisions and invest in new technology;
- Engage with the physical gold markets in ways that improve the consumer buying experience; and
- Engage with the physical gold markets in ways that improve the consumer buying experience; and Partner with distributors to grow market participation.
Opportunity #1: Capitalize on higher gold prices to grow profitability
The June–August gold rally has been an exciting time for gold producers as the metal’s value surged from below USD 1,300 per ounce in May to over USD 1,500 in August. Following several years of subdued trading activity, the summer rally finally presented an opportunity for companies to demonstrate their improved leverage to higher gold prices under a more constrained cost structure.
Previous gold rallies were often driven by rapid operating-cost inflation that offset the benefits of higher prices. However, falling gold prices and limited access to capital over the past six years have forced most mining companies to focus on operating efficiencies. These cost-cutting measures have successfully offset the previous decade-long trend of continual rising production costs.
As a result of the industry’s slimmed-down cost structure, many gold-focused mining companies should be able to deliver profit margins similar to those seen during their previous profitability peak roughly eight years ago but at gold prices significantly below the all-time highs set in the summer of 2011 (around US$1,900 per troy ounce). If they can hold their cost discipline at current levels, companies should be able to deliver significant returns to shareholders by either gradually reinvesting in their businesses or returning cash back to shareholders as dividends.
In a tough market where gold prices spent six years rangebound between roughly USD 1,150–1,350 per ounce until this summer’s rally, cost control has been a key differentiator between the top and bottom performing gold-mining stocks. However, after five years of stringent cost-cutting, most companies only see the potential for USD 10-50/oz of further potential cost reductions. The quick-and-easy changes have all been made and many of the cost reductions now come with higher capital—and may take years to fully realize. The current opportunity from optimization now seems relatively small in comparison to a gold market that can move up by USD 200/oz in less than three months, but it remains key for companies to maintain cost discipline so that any rise in gold prices can go directly toward improved earnings and cash flow.
Opportunity #2: Leverage increased scale to improve the business
As of late 2018, we have seen significant merger and acquisition (M&A) activity among the world largest gold producers. Barrick Gold merged with Randgold Resources, Newmont Mining acquired Goldcorp, and Barrick and Newmont created a joint venture to combine their Nevada assets, creating the world’s largest gold-producing complex.
In contrast to these mega-mergers and partnerships, M&A activity has been frustratingly slow amongst the smaller gold producers. Direct cost synergies from gold-mining mergers are low compared to many other industries, but we see several benefits to companies joining forces.
“Most of the gold items sold today are almost identical to those made 100 years ago. We believe more should be done to support the physical ownership of gold; new product introductions could represent a solid source of demand growth looking forward.”
Multi-mine companies should make better capital allocation decisions as they deploy capital towards only their best projects. Labor is another ongoing concern—there is a shortage of experienced workers interested and qualified to work in the mining industry. Larger, well-run companies should be more successful in the competition to hire and retain top talent.
Companies with multiple assets also help to diversify risk for generalist investors. These investors may not be interested in holding several gold companies in a portfolio or taking on the increased risk associated with owning a single-asset miner. Additionally, in a world dominated by index funds, there are also real advantages to having a larger market capitalization and better trading liquidity.
New technology is finally making its way to the mining industry, creating opportunities for automation and remote operation to be used to improve safety and increase efficiency. We see the roll-out of 5G wireless technology as a tipping point where technological innovation will finally be able to drive measurable efficiency improvements in mine operations. Implementing new technologies can be expensive, creating another opportunity for larger companies to differentiate themselves from smaller peers.
Opportunity #3: Create new ways for consumers to engage with gold
Although access to the gold market has improved dramatically over the past 46 years since we moved away from the gold standard, there is still significant room for improvement. Gold producers have a longer-term opportunity to engage more actively with the development of new gold products to further expand the existing end-markets.
With the help of considerable education and support from the World Gold Council , central banks around the world now recognize the role of gold as a store of value and a key part of their reserves base. As a result, central banks have moved from a major source of supply in the late 1990s to a significant buyer over the past several years.
The development and wider adoption of physical gold-backed exchange-traded funds (ETFs)—also partly due to the WGC’s efforts—have helped to expand market participation and create new sources of demand for gold. The introduction of physical gold-backed ETFs in the early 2000s was a significant step forward for the industry. These ETFs attracted new pools of capital to expand the market and helped to create greater efficiency in the price discovery mechanism.
Financial interest in gold has become one of the main drivers of gold prices, but still represents a relatively small portion of the overall market. Despite strong inflows since their creation less than 15 years ago, gold held in ETFs still represents less than 2% of the total gold in circulation but can represent a much larger portion of daily liquidity, and as a result, often has a significant impact on the gold price.
However, most of the gold produced each year is still bought as jewelry or small-investor coins and bars. Although the competition from ETFs has helped to lower premiums, the market is still highly inefficient. 3D printing and advances in material science have created new ways for consumers to interact with many materials, but little of this knowledge seems to have been applied in the gold industry outside of high-end electronics. Most of the gold items sold today are almost identical to those made 100 years ago. We believe more should be done to support the physical ownership of gold; new product introductions could represent a solid source of demand growth looking forward.
Opportunity #4: Further improve the consumer experience of buying physical gold
Ask a gold mining company CEO what they are doing to cut costs in 2019, and you might get a list of 20 projects. Ask what they are proactively doing to support the gold price, and you will probably get a very long pause before they try to find a way to redirect the conversation. It is a testament to the product they sell (gold) that they can be so removed from the marketing and distribution process. Gold is universally understood to represent value and safety around the world, yet many people struggle to find trustworthy sellers of physical old at close tomarket spot prices.
In our view, supporting markets to ensure consumers are getting proper access to your product at a fair price should be a core part of any well-run business. Greater participation should drive prices higher over time, and more ability to “buy the dip” without expanding premiums as prices decline should help reduce some of the downside volatility in gold.
Top-quality luxury goods and most of the world’s great brands are supported through controlled distribution. Retailers are not allowed to sell at any price they want, so why should retailers be able to put a gold necklace in a box and sell it for more than double the price?
Gold producers should be looking to support distributors that help get their product into the hands of consumers with the lowest possible markup for the value added to the gold. Beautiful jewelry possesses alluring, artisanal properties and deserves to sell at a premium to its melt value, but that premium should be proportional to the value- added.
Experience from the Gold ETFs has shown that a relatively small part of the market can have a significant impact on price. Producers don’t need to change the entire industry directly. They just need to create healthy competition by supporting distributors that are willing to embrace a higher volume, lower margin approach to selling gold.
Gold companies can provide support for this idea by extending credit and taking on gold price volatility in exchange for a fixed premium. As an investor, I would be very happy with a gold company that said they were extending the final sale terms such that they would receive a USD 5 premium to the average gold price in perpetuity in exchange for delaying a portion of one quarter’s sales for three months to support a more efficient market.
Tying it all together
The gold industry has been through a harsh downturn that has reset the playing field for gold producers. The industry now has an opportunity to use rising gold prices as a stepping stone towards building stronger and more profitable businesses. As we look out over the next several years, we see the opportunity for gold producers to fare significantly better as they create stronger businesses and modernize the sale and marketing of one of the best-recognized brands in the world — gold.
