Gold at all time highs, the miners yet to follow

On a background of wars, conflicts, elections and high inflation the gold price has surged nearly 50% over the last two years and, in recent days, surged to all time highs of over $2,500/oz. Investors may be wondering if they should add gold exposure to their portfolio or maybe if they missed the boat or, if they did have exposure, if this was the time to take profits.

Can the gold price go higher from here?

The strong gold price which we have seen since the beginning of the year (up c.20%) was initially driven by robust Chinese retail demand. This resulted in imports from the West, despite the Central Bank of China reporting a pause in gold additions through May and June, marking an increase in the Western demand for gold. Furthermore, we have also seen a shift in the west, with ETFs, after years of selling, move back into buying gold.

Whilst we have been outspoken about the fact that the link between US rates and the gold spot price have decoupled recently, global inflation expectations have continued to soften with the US & UK CPI dropping to 2.9% and 3.1% respectively, supporting rate cuts before year-end. This should be supportive of the gold price when the rate cuts eventually happen.

Gold miners have lagged, but profitability and momentum is building

But whilst the gold price has been surging, the gold miners have continued to lag the spot price significantly, trading at some of the most discounted levels that have been seen on earnings multiple and NAV’s. This can be attributed to the sector's prior cost inflation issues that have compressed producer margins despite the gold strength, especially during the COVID pandemic. These inflationary cost pressures are now easing and, in some cases, reversing, which should support improved cash generation for producers, given the higher gold price continuing through the second quarter of 2024.

So, following two consecutive quarters of a sustained high gold price, we are beginning to see that gold miners are benefitting. The fund’s largest position, Emerald Resources, saw its 1H24 Net income increase to A$51.6m from A$26.2m in 1H23. The story is similar for many other gold miners, leading to improved profitability and free cash flow as gold has continued to push higher.

We believe that this improved free cash flow will become more prominent in the gold mining sector, leading to a rerating of the unloved equities.

How to play this potential rerating

Golden Prospect Precious Metals is a precious metals fund focused on small and mid-cap miners; it is these companies that will benefit heavily from reversing inflationary pressures. When the gold price rises these miners typically see a more significant increase in their share price compared to major mining companies, as their profitability is more sensitive to changes, small increases in the gold price can lead to substantial improvements in profit margins and valuations, as we are beginning to see.

As one can see from the graph below, the fund tends to perform extremely well in times of uncertainty and crisis, such as the 2008 Financial Crisis and the COVID Pandemic, as these are times when gold and the gold mining equities have also rallied. The funds nature also provides investors with greater potential upside return given the gearing, which magnifies returns on the invested equities when performance is positive. Golden Prospect has witnessed some large rallies in price, with a trough to peak rally of over 500%, or during the COVID pandemic the fund recorded an over 300% increase in the share price, and most recently from October 2023 to time of writing this year rallying over 45%.

With Chinese demand resilient, Western demand recovering and the combination of the gold price at all-time highs whilst the miners close to all-time lows on price to NAV multiples, we believe the risk-reward profile is attractive, with a strong bias toward upside potential.