In the 1970s when gold was booming in South Africa, there were over 50 gold mining companies listed on the Johannesburg Stock Exchange. Today there are just six actively traded companies.
In order of size, they are AngloGold Ashanti (43%), Goldfields (25%), Sibanye Gold (16%), Harmony Gold (11%), Pan African Resources (3%) and DRDGold (2%).
The chart below shows their performance. The net effect is that the index is back to where it was when it started some 18 years ago, at the turn of the millennium.
While there have been some favourable times, one could only make money by trading the portfolio. A ‘buy and hold strategy’ has been very painful.
The monthly chart shows that while the gold index has been as high as 3 250 points in the past, today it is barely above 1 000 points. That is roughly 70% off its high.
Were there better times for miners?
There were indeed. My first encounter with gold shares as a young boy was in the 1970s. I remember excitedly catching the train during the school holidays to visit a large departmental store, Garlicks in Cape Town, for lunch. It was a lavish lunch sponsored by our great aunt. We made this family outing at least twice a year. Her father had left her a portfolio of gold shares which paid handsome dividends. We were the willing recipients of these windfalls.
In 1967, the Mint Refinery and the Reserve Bank of South Africa teamed up to launch the production and sale of the 1 oz Krugerrand. It was an extremely successful endeavour and as a result some 60 million plus Krugerrands circle the globe today. Many countries have followed suit.
At the pinnacle of the gold era in 1980, gold reached its high of $850 an ounce. At that stage the rand was at parity with the US dollar, or even a little stronger. That made gold then R850 an ounce too.
Today gold is barely at $1 210 – up a mere $360, or 42%, over the marathon time frame of 38 years. Fortunately the rand has substantially weakened; it is now above R14 to the dollar. That translates into around R17 000 an ounce of gold, or 20 times more than what it was then. That is significant growth. Yet despite this, and after allowing for inflation, South African gold miners are battling to make a profit.
What caused the gold price to decline?
I am not exactly sure, but I do know of three key factors that would have played a major role. Firstly, the US hiked interest rates to a record 19% per annum to entice investors to part with their gold. It was too good an offer to refuse. Enough investors surrendered their gold and elected for the cash in the bank. This put pressure on the gold price as demand weakened.
As a direct result of falling gold prices in the 1990s, many gold miners made use of hedging. This meant they sold their gold forward, receiving the cash upfront at a predetermined price and delivering the gold later. It had the benefit of ensuring that mines could operate and remain in business, funding all their ventures and keeping their staff complement. The downside was that they arranged their own demise as the price was controlled and systematically forced downwards.
Another factor is that central banks were, for at least 10 years, net sellers of the gold held on their balance sheets. Consequently supply was greater than demand and the gold price fell to its all-time low of $250 in December 2001. The United Kingdom was the big seller here, disposing of half of its assets at rock-bottom prices.
In this difficult period South Africa largely stopped exploring and developing new mines. Its focus moved to outside of South Africa. The country went from being the world’s leading producer up until 2006, to now only rank as the eighth biggest producer.
At their peak in the 1970s South Africa’s gold mines produced more than 1 000 tons per annum; now they produce barely 140 tons. But this could change very quickly if the issues affecting the sector can be resolved and the doors to growth again flung open for investors.
Will the gold price ever rerate again?
It would appear that we may be in a sunset industry. Yet there are early signs of recovery. Oil – known as ‘black gold’ – has rallied from its low of $30 to over $85 a barrel (although it has since pulled back significantly). Could this be a leading indicator of recovery in the resource sector?
Because of the low price of gold very little has been spent on exploration. In 2009, I was involved with the first gold mine to be built in South Africa in 30 years, Gold One.
Developed by CEO Neal Froneman, the mine was very profitable because its assets were shallow, only 500 metres deep. It was easy to mine. Costs were amazingly low, around $500 an ounce. It was not long before the Chinese acquired a strategic stake and ultimately made an offer to buy out all the other investors.
It may just be that when the gold price does run there will not be sufficient supply because of the lack of new mines being built. This of course may cause the price to run a lot quicker and higher as a result of short supply.
We need to see the gold price rise significantly for a new era of gold to be heralded in.
A few pundits are saying that the world’s monetary system has not been fixed since the financial crash of 2008 and that, if anything, it is broken. If this should prove to be correct, it could cause a rapid hike in the gold price.
Some credible analysts are forecasting a gold price as high as $10 000 an ounce. One of them is highly respected US gold analyst Jim Rickards.
How best to buy the gold miners?
There are a variety of gold mines, all with different aspirations, but as can be gleaned from the long-term chart above, the gold miners have all been beaten up. There are no exceptions. Considerations would need to made by weighing up where one sees gold being best mined and familiarising oneself with the management team overseeing it and their strategy going forward.
AngloGold Ashanti has the majority of its assets overseas and has chosen to be well diversified on different continents.
Goldfields split its company into two parts, electing to hold most of its assets offshore, except for its South Deep mine in South Africa, which has the second biggest known resources in the world.
All of its other South African assets were hived off into the new gold company Sibanye Gold and, later, Sibanye-Stillwater. Sibanye Gold performed well initially, but lately it has given a lot of its profits back largely due to huge offshore acquisitions in a US company called Stillwater. It is a palladium and platinum producer. In addition, it has acquired more platinum assets in South Africa. The group is well managed by Neal Froneman, the pioneer behind Gold One who has a proven track record of running a mine successfully.
Harmony Gold’s mines are exclusively in South Africa, although they are busy with a long-term development project in Papua New Guinea. As a result, it performs best when the rand weakens.
Pan African Resources, one of the two junior miners, is re-mining the old mines in Mpumalanga towns such as Barberton, where the early finds of gold were made. Methods of extracting gold from the ore body have been considerably enhanced since then.
Lastly, there is DRDGold, which focuses on reworking all the mine dumps. Much of the gold was not well extracted in the early days, so these are value hills that are reworked. The processing cost is much cheaper than mining gold. They together with Harmony will also outperform the other mines should the rand weaken.
In conclusion, gold shares are extremely cheap on a relative basis – and possibly the cheapest they will ever be.
In Part 3 I will discuss the Old Mutual Gold Fund and how to protect yourself in the event of a market crash.
David Melvill is an independent investment advisor based in Montagu.