Gold shares under pressure: Is there long term value?

Short term environment negative for local gold miners

In a renewed risk on environment, as the prospect of a COVID-19 vaccine nears fruition and the dusts starts to settle on the US elections, gold’s safe haven appeal has been severely diminished in the short term. Local miners contending with the declining commodity price will have also seen a softer dollar equating to a significantly firmer rand, adding further pressure to exports of the precious yellow metal.

The below chart of NewGold ETF shows how the rand price of gold has been in a firm downtrend since August this year, having given up 25% over the last three months or so. NewGold is an exchange traded fund, structured as a debenture, reflecting 1/100^th of a troy ounce of gold, traded in rand terms.

Are local gold shares offering value?

While local gold miners have been under short term pressure, exaggerating the downside moves on the ZAR price of gold, broker ratings and long term price targets are suggesting longer term value.

The below table shows South Africa’s top 4 gold miners (AngloGold Ashanti, Harmony Gold, Gold Fields and Sibanye Stillwater) in terms of market capitilaisation. Within the table, a consensus of broker ratings and price estimates of these companies, from Thomson Reuters, as of the 25^th of November 2020 are contained.

The share prices referenced within the table are derived as of the time of writing before close of business on the 25^th of November 2020.

The table highlights a long term average rating of ‘Hold’ on AngloGold Ashanti and ‘Buy’ for Harmony Gold, Gold Fields and Sibanye Stillwater.

It is important to note that while all the shares appear to offer a current pricing discounts to long term target prices, the short term volatility and downside momentum could still put further pressure on share prices over the coming days and weeks.

A pair trade scenario

In lieu of the short term weakness versus a discount to a long term view consensus estimates, our preferred approach to trading within the localised gold sector is to do so as a pair. Gold shares do tend to exaggerate movements both up and down relative to the underlying pricing (ZAR pricing in this case) of the commodity.

With this in mind we consider the following pair trade opportunity.

AngloGold Ashanti vs NewGold Issuer Pair Trade

The pair considers a Long AngloGold position against a Short NewGold position. The net result of these combined trades looks for a 13.9% profit margin. A stop loss is considered of equal proportion to the expected gain.

A successful pair trade can be realized 1 of 3 ways:

1. The long position rises while the short position falls

2. The long position rises faster than the short position rises

3. The short position falls faster than the long position falls.

The blue line on the chart represents the AngloGold / NewGold ratio which currently trades at 2 standard deviations below the mean (red line). A successful trade would require the ratio (blue line) to return back to the mean.