The gold dividend: An Aussie minnow leading the charge
David Baker, a co-founder of London-based Baker Steel Capital Managers, is responsible for investing more than $1.2 billion in gold mining companies, so you would be surprised to hear that one of his favourites has a market cap of only $11 million.
He cites little-known ASX-listed Korab Resources as one of his favourites. Sure, he likes the fact that the company is sitting on a 2 million-ounce gold resource in the middle of the Ukraine, which is “at a decent grade, which could be mined cheaply”. He also likes that it has assets that it is trying to sell for $15 million.
But what really impresses Baker is that this month the company said that once it becomes a gold producer, in addition to “dollar” based reporting it will report its production results in terms of ounces produced, and net ounces retained after cost of production.
Korab goes further than this and says it will give shareholders the option of receiving their dividend in gold, which is in many ways equivalent to delivering investors a royalty.
This is music to the ears of David Baker: “If you buy gold shares, the miner goes to a lot of effort to dig it up and convert it to gold, which is what the ETF holders want!
“It gives investors more clarity and makes mining companies realise that their focus should be on maximising ounce returns to shareholders. If this happens maybe more people might buy them.”
ETFs, or exchange traded funds, whose movements are based on the price of gold, have been soaking up the vast majority of investors' dollars since they came onto the scene about 10 years ago.
Their popularity is based on investors looking for access to the yellow stuff, which is in increasing demand as the world becomes a more uncertain place, and currencies get debased by monetary policy.
Consequently, the gold miners are finding it harder than ever to attract funds. In the past five years the FTSE Gold Mines Index has declined about 17 per cent. In contrast the gold price, which the ETFs trade in line with, has more than doubled.
Gold miners are now cheaper than ever. Before the financial crisis, gold producers routinely traded at big premiums – on price earnings ratios of 20 to 30 times, versus the market average of 15 times. These days they trade on single-digit PEs.
Big money to be made if gold miners get it right
Should the gold price rise, these miners are more leveraged than ever. For example, if the gold price climbs 15 per cent from its current level of US$1635 (A$1578) to its record high in September 2011 of US$1920 an ounce, he estimates his fund could run up more than 50 per cent if this happens.
Gold companies are victims of the US dollar, which is a “flawed currency” according to Baker, because its value is being undermined by “quantitative easing” or QE, which has led to trillions of greenbacks entering the system.
Once upon a time (in the 20 years following the gold peak in 1980) it was sensible for a gold producer to forward sell its gold production to take advantage of the US currency's reserve status.
Now, it is clear that the US dollar is depreciating as the gold price rises so forward selling makes no sense. And Baker laments that gold companies “still feel compelled to sell the precious commodity immediately having been mined and then to convert their margin into depreciating dollars”.
While dollar costs are going up for miners, these same costs have stayed steady as a percentage of ounces mined. For example, the capital cost of a new gold mine is around 10 per cent of its gold reserves; while mining the gold costs around half that gold.
What is left for shareholders is 20 per cent of the gold in the mine, according to Baker's analysis. Of this, he says that companies should be paying out 5 per cent of their gold reserves in royalties.
The majority of gold companies may never adopt Baker's suggestions, but it is hard to disagree with this statement from a man who has more invested than most in the yellow stuff:
“To produce an ounce of gold takes a lot of blood, sweat, tears and hard work; to produce a dollar takes the press of a button.”
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