Mon, 7 May 2012
Morningstar's Joung Park explores why gold miners have lagged gold prices in recent years and what needs to happen for that trend to reverse.
Jeremy Glaser: For Morningstar, I am Jeremy Glaser. The Wall Street Journal recently named six Morningstar equity analysts Best on the Street. I am joined today by Joung Park. He was named one of the best mining and metals analysts. Joung, thanks for joining me.
Joung Park: Hi, Jeremy, it's good to be here.
Glaser: So, let's take a look first at the relationship between gold and gold miners, which you cover. Certainly, gold has handily outperformed the miners. What's going on there?
Park: Yes, you're exactly right. Gold has gone up by 10% in 2011, while gold-mining equities were significantly underperforming bullion. The reason behind gold's outperformance in the last couple of years is that there has been tremendous appetite for gold-backed exchange-traded funds, such as the GLD, and there has also been increase in jewelry demand from emerging countries with the historical affinity for gold such as India and China.
But we think that the biggest driver behind higher gold prices during the past couple years has been central banks as a group switching from being net sellers to being net purchasers of bullion. These guys buy gold by the ton and not ounces or kilos like regular investors. So, their actions can have a big impact on gold prices.
On the contrary gold-mining shares have actually fallen during the past year, going down by 16% as a group. And this must leave investors scratching their heads because gold is up, while gold miners, which are supposed to track gold, are down. We think that there are a number of reasons for this, but the main thing is that investors are putting their money into gold rather than into gold-mining shares because the mining shares have additional risks such as higher-than-expected production costs, geopolitical risks, and issues with operating the mines themselves.
Glaser: Is there anything that can bridge this performance gap?
Park: Yes, that's a great question. We think that the first thing is dividends. Due to higher cash flows that these miners are generating, they have greatly increased their dividend payouts, and as a result some of them are paying in excess of 2%, which is a nice yield. Some miners have become even more creative and linked their dividends to the gold price itself, and we think that these attractive dividend schemes could help persuade some investors to put their hard-earned money into the miners instead of into gold.
The second thing is valuation. As the miners continue to lag gold, the ounces in the ground that's owned by these miners becomes so much cheaper than the gold that you can buy on the market through ETFs or jewelry. So, we think that maybe investors will see that valuation disconnect and purchase more mining shares instead of gold.
Glaser: What are some of your favorite miners?
Park: The two miners that we like the most currently are Yamana Gold and Eldorado Gold. These two companies are both high-quality miners with attractive growth potential and below-average production costs. [Each company's share prices currently warrant a Morningstar Rating of 4 stars], but we think that Eldorado is slightly more attractive.
Glaser: What about those two companies do you really like right now?
Park: We think that making a stock call is about knowing what the market thinks about the company, knowing what you think about the company, and knowing why your views are more likely to be correct than the market's. In the case of Yamana Gold, this is a company that's been viewed as a perennial underperformer by the market because it failed to meet expectations in 2008 and 2009. But we thought that this was the result of the company digesting some major acquisitions that it made and that it will be temporary. Sure enough the company has started to meet those expectations and even exceed them. As a result the shares have outperformed its peers in 2011 going up by 16%, but we think that this stock still has some more room to run.
Going to Eldorado Gold, we think that this is our most attractive idea in the mining industry currently, and the story with Eldorado Gold is that this is a premium gold miner with a narrow moat that has always traded a big premium to its peers. But the stock fell off its perch in late 2011 when it made some major acquisitions in Greece that the market didn't like so much. Now why did the market react negatively? Greece for the last couple of decades hasn't been the best place for a miner to operate given its environmental opposition to mining, but we think that things have changed in Greece during the past couple of years. Athens is currently desperate for foreign capital and job creation given that the country is going through the austerity measures, and we think that Eldorado can provide all these things for Athens. Therefore, the company will be able to successfully operate in that country, and we think that as the market sees that Eldorado can create value through this acquisition, that will serve as a positive catalyst for the share price.
Glaser: Joung, congratulations again and thanks for talking with me.
Joung Park: Thanks, Jeremy.
Jeremy Glaser: For Morningstar, I am Jeremy Glaser.