Aktieutbildning.nu – Gold Mining Companies – the most Mispriced Investment of the Decade?
The price of gold has more than doubled since its low in 2021!
Gold set 53 new price records in a single year and has grown to become one of the world’s largest reserve assets. It is now trading at around $4,400 per ounce.
During Mikael Hellberg’s 35 years as a professional asset manager—including managing portfolios worth over 20 billion kronor at Handelsbanken Fonder—he has seen numerous market cycles come and go. One recurring pattern is a market’s inability to price itself when paradigm shifts take place. Right now, such a shift is happening in gold and, specifically, in the companies that mine this precious metal. Read the original article here in Swedish by: Mikael Hellberg, Aktieutbildning.nu.
The gold mining companies—whose entire business models are based on selling this commodity—are valued at the same level as they were in 2015. The market—and even the mining companies’ own management teams—does not seem to believe that the current gold price is sustainable. They are accumulating cash instead of reinvesting.
It is in this mistrust that the institutional investment opportunity lies.
Let’s take a look at the fundamentals.
1. Gold Prices Have Soared—Mining Companies Are Still in the Starting Blocks
To understand the risk, we need to look at historical relative valuations. If we price the U.S. stock market (S&P 500) in terms of gold, we see that gold is not currently trading at an extreme premium relative to stocks, but rather just above its historical average since 1970.
The times when gold has actually been expensive relative to stocks (such as at the peaks in 1980 and 2011) have been the worst possible times to buy. We are far from those levels today. Yet gold mines are valued as if the party is already over.
2. Cash Flows: The Myth of Capital Destruction in Mining Companies
A common objection I often hear is that “mining companies are value traps that burn through all their money.” That was true a little over a decade ago, but it’s not true today. When gold reached its last cyclical peak in 2011, the world’s largest mining companies generated virtually no free cash flow at all. Why? Because their capital expenditures (capex) were spiraling out of control. They took the best gold prices in a generation and burned through the money.
Today, the picture is completely different. Now, the largest companies are generating hundreds of dollars in free cash flow per ounce, while their capital expenditures remain flat. The industry has learned its lesson. This is not the same industry that was burning through cash in 2013, even though the market price is as such.
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3. The Historical Valuation Gap
If we take the Barron’s Gold Mining Index (an index with data dating back to 1940) and divide it by the price of gold, we can determine how the market values the Gold Mining companies relative to the metal they mine.
During the 1980s and 1990s, this multiple often ranged between 1.5 and 2.5. At its low point in 2016, it had fallen to a historic low of 0.22. Where do we stand today, after gold has broken record after record? We’re at around 0.50. That’s roughly one-third of the 55-year historical average. The market, therefore, still refuses to pay for the underlying value creation of the mining companies.
4. Macro Analysis and Risk Management: Preparing for Bumps in the Road
As I always emphasize, there are no straight upward lines in the stock market. Risk management is the be-all and end-all.
The main short-term risk to the price of gold right now is the relationship between gold and oil. Historically, the average has been that one ounce of gold buys about 16 barrels of oil. Recently, we’ve seen extreme levels. For this ratio to normalize, either oil must become more expensive, or gold must fall back.
Expect volatility. A 30% decline in gold-related assets during a long-term bull market is, historically speaking, perfectly normal. It doesn’t contradict the long-term thesis. It’s just the price you pay to be part of the journey.
5. The Hidden Leverage
The great thing about mining companies is the leverage built into their business model. A mining company earns the price of gold minus its fixed production costs. When the price of gold rises, and costs remain relatively fixed, the profit margin skyrockets. If the price of gold rises by 60%, this could mean that a mining company’s free cash flow nearly doubles. Right now, you can buy into these potentially doubled cash flows at a valuation that assumes profits will shrink.
How do we move forward from here?
Macro analysis and sector rotation are crucial for building a long-term, stable portfolio. It’s not about making quick profits, but about proven methods and patience. This is exactly what we focus on in my training courses and in our networks.
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