Cejay Kim September 9, 2015 Category: Research
We are mired in almost the longest gold bear market in history. Since April 2011, the (HUI) Gold BUGS Index has declined more than 80%, while in the same period physical gold has declined 25%.
Needless to the say, miners have experienced significantly more volatility than the underlying commodity. This is because gold producers are leveraged to gold prices.
For example, let's pretend that a company's total cost to mine gold is $500 per ounce, and the current gold price is $1,000 per ounce. The value of the gold company is calculated based on a $500 per ounce margin.
Now let's pretend that gold prices increase by 20% to $1,200 per ounce. Keeping the total costs per ounce the same, margins have now increased to $700 per ounce, or by 40%. Thus, a gold miner's stock price will almost always move more than the price of gold.
Looking at the top five gold companies by market cap on the TSX, the producers have outperformed the Gold BUGS Index. Agnico Eagle, Goldcorp and Barrick remain the go to investments for investors who continue to want gold exposure.
Now here is the interesting part. Gold royalty/stream Companies have outperformed the HUI and have even made their investors money. A royalty/stream company is different from a conventional producer as it does not operate, develop, or conduct any exploration. This minimizes cost exposures and creates a very nice cash flow situation.
Agnico Eagle, Goldcorp and Barrick all have cut dividends to weather the markets. Franco Nevada and Royal Gold have both increased dividends!
Even in the unforgiving gold markets, cash flow remains king. However, you can be sure when the prices of gold rebound, it will be the producers that will outperform the royalty/streaming companies. Numbers simply do not lie.