Gold Sector Overview

Gold prices continued to rally as investors flocked to buying the safe haven amid escalating rifts between world’s two biggest economies US and China while there is a heightening concern over the second wave of coronavirus outbreak. On July 28, 2020, gold spot prices hit a record high of US$1981.22 per ounce in international markets. Globally, investors have enfolded yellow metal in 2020 as a crucial portfolio hedging strategy. Going forward, expectations for quick V-shaped recovery from Coronavirus pandemic are shifting towards slower U-shaped recovery. Also, potential setbacks from another wave of the outbreak can lead to a W-shaped recovery in the global economy. However, regardless of the potential recovery type, the deadly virus outbreak has a lasting effect on the asset allocation, and it will continue to reinforce the role of the yellow metal as a strategic asset.

Gold outperformed Major Asset Classes in H1FY20: Gold has a splendid rally in the H1FY20, surged approximately 17%, whereas the MSCI World Price Index is featuring a negative price return of 5.48%. Though equity markets around the world rebounded sharply from their Q1 lows, the high level of uncertainty surrounding the COVID-19 pandemic and the ultra-low interest rate environment supported strong flight-to-quality flows. Like money market and high-quality bond funds, gold benefited from investors’ need to reduce risk, with the recognition of gold as a hedge further underscored by the record inflows seen in gold-backed ETFs.

Source: World Gold Council

Gold Demand Trends

Gold ETFs close H1 with record US$ 40bn of net inflows: Gold-backed ETFs recorded their seventh consecutive month of positive flows to June 2020, adding 104 tonnes equivalent to US$5.6bn or 2.7% of assets under management (AUM), taking global holdings to a new all-time high of 3,621 tonnes. This brings H1 global net inflows to 734t (US$ 39.5bn), significantly above the highest level of annual inflows.

Source: World Gold Council

Central banks remain net gold buyers in Q1FY20: During the first quarter of 2020, Central bank’s gold buying slowed but stayed in line with longer-term average level. Amid tumultuous time in Q1FY20, which saw significant market volatility and an unprecedented global financial stimulus, central banks bought 145t of gold, down 8% y-o-y. This is, however, 9% above the five-year quarterly average of 132.9t. While central bankers around the globe were focused on the measures needed to contain the economic impact of COVID-19, the need for robust, liquid and diversified international reserves was apparent. And positive net purchases of gold confirm that it remains an important component of those reserves.

Canadian Gold Mining Sector

Canada is the fifth-largest gold producer in the world. It produces about 182 tonnes of gold and consumes about 17 tonnes, making it one of the top gold exporters of the world. There are more than 250 gold stocks have listed and traded on the Toronto Stock Exchange and Toronto Venture Exchange. However, out of these, there are approximately 25 companies which are having a market capitalization of more than 1 billion Canadian Dollar, including Barrick Gold Corp, Franco-Nevada Corp, Wheaton Precious Metals Corp, Agnico Eagle Mines Ltd, Kirkland Lake Gold Ltd, and Kinross Gold Corp. to name a few. Shares of gold stocks having a market capitalization of more than 1 billion Canadian Dollar have surged an average ~ 54% over the year, ~ 71% on a YTD basis and ~ 25% in the past three months. However, there are many such as Freegold Ventures Ltd, Aura Minerals Inc, Frontline Gold Corp and others who have turned their shareholders’ fortune and delivered a whopping price return of approximately 2,666%, 732%, and 230%, respectively.

 

Why should one invest in Gold Mining Stocks?

A Leverage Bet on Gold: Investing in gold stocks or a gold-mining ETF is, to a large extent, a leveraged bet, considering the fact that the prices of gold are continuously rising. Higher gold price is likely to have a positive impact on the profitability of gold miners. Elevated gold prices would result in higher revenue and cash flow for the gold miners.

Ballooning Valuation of equity assets: Ballooning valuation of equity assets, which has not built upon strong fundamental is raising investor’s concern across the globe; therefore, increasing the chance of pullbacks in the equity market. Global equities were on a virtually uninterrupted one-way trend for more than a decade. The COVID-19 pandemic changed that, resulting in a significant pullback, with all major equity indices dropping by more than 30% during the first quarter. However, equities have recovered sharply since – especially tech stocks. But stock prices do not appear fully supported by company fundamentals or the overall state of the economy. However, rally in the gold stocks (explorer, miner and refiners) is backed by an increase in the higher average realized gold prices, driven by elevated international gold prices. And, we believe that the kind of inflow Gold ETFs are witnessing, as it recorded seven consecutive months of positive flow, adding 104 tonnes in June 2020 and taking global holdings to new all-time highs of 3,621 tonnes, is expected to further push gold prices in the international commodity market.

Outlook

The COVID-19 pandemic is upending asset allocation, with central banks across the globe have aggressively slashed rates and enhanced asset purchasing programmes to stabilize and stimulate their economies. However, these actions are leading to several negative consequences on asset performance. Further, widespread fiscal stimuli and ballooning government debt levels are raising concerns about a long term run-up of inflation, or significant erosion of the value of fiat currencies. Also, we believe that inflow in Gold-backed ETFs will continue to increase, given the heightened uncertainty in the other asset classes.

The recent rally in gold mining stocks is expected to continue at least in the near- to mid-term given the overall volatility in the broader market. COVID-19 pandemic, which has infected approximately 17 million people around the world and fatalities surged to about 0.67 million, has induced unprecedented uncertainty amongst the decision-makers at large. Investment avenues ranging from investment grade to non-investment grade or speculative asset classes, all have significantly underperformed, and broader markets have tested a multiyear low. Amid the falling interest rate environment in the wake of heightened economic uncertainties and increased volatility in the speculative asset classes has brought the safe-haven yellow metal “Gold” into the limelight again.

After understanding the Gold sector, let’s take a look at one TSX listed Stock.

 

SSR Mining Inc.

SSR Mining Inc. (TSX: SSRM) is a Canada-based precious metals producer with three operations, including Marigold gold mine in Nevada, U.S., the Seabee Gold Operation in Saskatchewan, Canada and Puna Operations in Jujuy, Argentina. The company has two feasibility stage projects and a portfolio of exploration properties in North and South America.

Investment Rationale

• Rising gold prices likely to enhance SSRM’s margin and profitability: The spot gold price inched higher into record territory and traded at US$ 1,981.22 per ounce on July 28, 2020. Gold and gold stocks have been on a great run since hopes for a V-shaped recovery were doused by a building summer coronavirus wave in mid-June. Investing in gold stocks seems to be a safe bet, considering the fact that gold prices are continuously rising. The higher gold price would have a positive impact on the profitability and margin profile of the gold miners. SSRM in its Q1FY20 financial statement reported that all-in sustaining cost of production (AISC) amounted to US$1,277 per ounce of gold, that means increases in the price of gold above that level would go straight to the bottom line. Hence, we believe that rising gold price will bolster SSRM’s profitability and margin and thereby better return on equity for the existing and potential shareholder.

• Valuation at a discount to the industry peers: Despite a solid run that SSRM share has recorded over the past one year, there is a valuation gap between SSRM and its peers. If we look at the Enterprise Value To Sales multiple (LTM), SSRM shares were trading at an EV/Sales multiple of 4.25x, whereas its peers (in terms of market capitalization) Torex Gold Resources Inc, Alamos Gold Inc, Pretium Resources Inc, First Majestic Silver Corp, Wheaton Precious Metals Corp, Argonaut Gold Inc, and B2Gold Corp are trading at an average EV/Sales multiple of 7.45x, which implies a valuation gap of ~42%. And, from the LTM Price to Cash Flow standpoint, SSRM shares were trading at a P/CF multiple of 15.62x, whereas its close peers were trading at an average LTM Price-to-Cash Flow Multiple of 18.42x, reflecting a valuation discount of ~15%. We believe that the valuation gap between SSRM shares and its peers would close in the near-term, given the rising gold prices and expectations for quick V-shaped recovery from Coronavirus pandemic are shifting towards slower U-shaped recovery, which is likely to drive gold prices higher.

• Merger with Alacer Gold to diversify the mining portfolio: On July 10, 2020, SSR Mining Inc. and Alacer Gold Corp. announced the receipt of the required shareholder approvals for the previously announced at-market merger of equals pursuant to a plan of arrangement. On closing of the Transaction, each of the Alacer issued and outstanding common shares will be exchanged for 0.3246 of an SSR Mining common share. An all-stock merger with Alacer Gold Corp will result is a new company that can produce roughly 780,000 ounces of gold each year. The merger would result in the mining portfolio diversification in terms of geographic locations.

• Strong Balance Sheet: SSRM has a robust balance sheet with total debt contribution of 13% to the capital and interest coverage ratio of ~ 5x, which implies that the company is less leveraged. Further, the Debt/Equity ratio of SSRM stood at 0.15x, lower than the industry peer’s average debt/equity ratio of 0.25x. Also, the current ratio of the company – a quick measure of the liquidity position stood at 5.28x, significantly higher against the industry average of 1.38x. This ensures that the company has ample liquidity and can easily meet its short-term obligations using its current assets. 

• Higher Relative Strength: Shares of SSRM have outperformed the benchmark index by ~49% on a YTD basis, ~42% in the past three months, and ~26% in the last one month. Further, on a YoY basis, the relative outperformance of SSRM shares against the benchmark index stood at ~68% and over the last six months, its shares outperformed the benchmark index by ~71.5. The above outperformance of the SSRM shares implies greater relative price strength and depicts a strong bullish price trend in the stocks, and potential for an upwards movement from the current price levels. 

• Risk Associated to Investment: The group’s performance is directly related to the gold prices. Any volatility in the gold prices would hamper the group’s performance.

Financial Highlights: Q1FY20 (ended on March 31^st, 2020)

Source: Company filings

The company’s revenue for the first quarter ended on March 31st, 2020, recorded solid growth of 30% to US$ 164.5 million against US$ 126.25 million reported a year-ago period, primarily driven by a higher realized gold price at the Marigold mine and Seabee Gold Operation and higher silver ounces sold at Puna Operations.

Income from mine operations stood at US$ 44.8 million in the first quarter of 2020 and generated a gross margin of 27% compared to income from mine operations of US$ 30.2 million and a gross margin of 24% in the first quarter of 2019, respectively. Relative to the comparative quarter of 2019, income from mine operations was higher at the Marigold mine and Seabee Gold Operation mainly due to 22% and 24% increases in realized gold prices, respectively. In the first quarter of 2020, the group generated a net income of US$ 24.0 million, an increase of US$ 18.2 million compared to net income of US$ 5.7 million in the first quarter of 2019.

Cash generated from operating activities in the first quarter of 2020 increased to US$ 58.7 million compared to cash used in operating activities of US$ 0.3 million in the previous corresponding period.

Further, the company maintained strong balance sheet and liquidity at the end of the first quarter of 2020, with cash balance at US$ 398.4 million and marketable securities of US$ 50.3 million, while total convertible debt outstanding was reduced to US$230 million during the quarter. The company has maintained high-grade production at Seabee gold Operation, produced 29,521 ounces of gold at cash costs of US$544 per payable ounce of gold sold.

Stock Performance

At the closing on July 29, 2020, SSRM shares traded approximately 2.38% lower at CAD 31.99. In a year-over period, its shares have tested a 52w high of CAD 33.44 on July 27, 2020 and a 52w low of CAD 12.12 on March 16, 2020. At the last traded price, its shares traded approximately 163% above its 52w low price level and approximately 4.3% below its 52W high price level, which reflect that the stock has had strong run-up after March 16, 2020 bottom price level.

1-Year Price Return (as on July 29^th, 2020, after the market close). Source: Refinitiv (Thomson Reuters).

On a YoY basis, its shares have surged approximately 50% and increased ~28% on year-to-date basis. Also, at the last closing price its shares traded well above the crucial long-term and short-term support level of 200-day, 100-day, 50-day and 30-day simple moving averages, which reflects strong uptrend in the stock.

Valuation Methodology (Illustrative): EV/EBITDA based Valuation Metrics

Note: All forecasted figures have been taken from the Thomson Reuters. 

Stock Recommendation

With precious metals performing very well as of late, many investors are looking for ways to add gold to their portfolios. We believe that investing in gold stocks is one of the easiest ways to profit from skyrocketing gold prices. The gold prices are likely to inch northward owing to higher volatility in the equity market, which is driving the investors to rush towards the safe haven, which is gold. Further, ETFs are creating a strong demand for the yellow metal, which is one of the key reasons behind the gold price rally, and this trend is likely to continue in the near future. Higher gold prices bode well for the company’s revenue and cash flow. Further, an all-stock merger with Alacer Gold Corp. would result is a new company that can produce roughly 780,000 ounces of gold each year. The merger with Alacer would diversify the group’s mine portfolio in terms of geographic locations. The merger is likely to reduce the cost and help the group in creating substantial free cash flow for its shareholders.

The shares of SSRM have significantly outperformed the benchmark index by 49% on a YTD basis, 42.2% in the past three months, 25.5% over a month. Also, its shares were hovering well above the crucial short-term and long-term moving averages, implies strong uptrend in the stock. The group has ample liquidity and strong balance sheet. The group’s long-term debt to capital ratio stood at 13.1%, which is lower than the industry average of 13.8%.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a “Buy” recommendation at the closing price of CAD 31.99 (as on July 29, 2020, after the market close), with lower double-digit upside potential, based on the NTM Peer’s Average EV/EBITDA multiple of 7.56x, on the FY20E EBITDA. We have considered Alamos Gold Inc, Pretium Resources Inc and B2Gold Corp etc., as a peer group for the comparison purpose.

*Recommendation is valid at July 30, 2020 price as well.

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Disclaimer

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