Valuations on gold mining stocks are at what we believe is a 25-year low and we believe gold sector M&A is a factor which would drive valuations to normalise

Key points

• Valuations on gold mining stocks are at what we believe is a 25-year low.
• We believe gold sector M&A is a factor which would drive valuations to normalise.
• We believe that appetite to acquire gold producers could come from outside of the precious metals sector.
• A ‘gold premium’ for gold producers has prevented this from taking place in the past.
• The ‘gold premium’ has disappeared and we believe that this will prove a temporary phenomenon.
• For the first time, we believe that it would be possible (and rational) for industrial metals miners to acquire major gold miners.

Insight

We believe that unusually, appetite to acquire gold producers could come from outside of the precious metals sector. Traditionally gold miners have traded at a premium to other mining companies on the basis that established, well managed, long-life gold producers generally have a beta of less than one (driven by gold’s safe haven characteristics), relative to the equivalent miner producing industrial metals (e.g. copper) having a beta of greater than one. This attribute creates what is known as the ‘gold premium’ and over the long-term has resulted in those established gold miners trading on one-year forward price-to-free cashflow multiples of around 20 times and copper miners trading on around 10 times.

This meant that gold miners were discouraged from acquiring copper miners because of the risk to the gold premium of their existing assets and copper miners were discouraged from acquiring gold miners because of the relative valuation and risk to the gold premium of the assets they were acquiring.

At the present time using spot commodity prices, the long-term valuation dynamics described above have inverted. For example the world’s largest publicly traded gold miner, Newmont is making 54% EBITDA margins and trading on 9 times (less than half its typical long-term mid-cycle multiple) and the world’s largest listed copper miner, Freeport McMoRan is making 40% EBITDA margins and trading on 22 times (more than double its typical long-term mid-cycle multiple).

Clearly part of the reason is that markets assume the copper price will be higher and the gold price will be lower in future, however this doesn’t account for the magnitude of the difference (especially considering the relative beta, which is akin to one of the laws of physics).

So what? For the first time, we believe that it would be possible (and rational) for industrial metals miners to acquire major gold miners. After all, only approximately 80% of what Newmont produces is gold (with the remainder being industrial metals) and approximately 80% of what Freeport McMoRan produces is industrial metals (with the remainder being gold). Further, exploring for, developing and operating most gold mines is not materially different to most copper mines.