An article in Barron’s this week pointed to technical factors at play. First, the price of gold versus gold equity has been artificially high over the past few quarters and is now leveling back to a more “normal” ratio.
Another reason is that the gold mining industry has been quite inefficient, putting downward pressure on profit margins. The past few years have been marked with heavy expenditures, with relatively little new profit streams to show for it. For example, deep-level mining in South Africa has been plagued by safety issues, depleting ore quality, poor infrastructure and skill shortages.
These inefficiencies and a series of acquisitions characterized by low valuations made investors squirmy.
However, according to the Wall Street Journal, there’s a lot of evidence suggesting mergers with little or no premiums may be the ticket to increasing profits in the gold mining industry.
Typically, these types of mergers have no designated “new owner,” and are instead consummated for mutual benefit. The success in such ventures usually comes sometime after the deal closes, as weaker companies combine to become one stronger entity with lower costs.
It’s easy to see how economies of scale can only be a benefit to a resource-intensive industry such as mining. Then again, culture clashes and management infighting aren’t unheard of.
One final factor is worth mentioning. As I wrote in a previous blog, gold miner ETFs often hold companies that mine metals and minerals other than gold.
Since gold is arguably the least cyclical metal—investing in companies that extract metals besides gold helps fuel price increases when consumer demand rises for products that use, say, rare metals in manufacturing. China’s fascination with the iPhone and other electronics is an example of this.
A lot of cross-currents are at play here, but gold miners are finally outperforming gold like so many have said they would, and I for one am excited to see if their Cinderella moment will last.
At the time this article was written, the author held no positions in the securities mentioned. Contact Ana Kostioukova @ [email protected].