A closer look at Gold Mining Companies & ESG

Those familiar with my investment approach will know that I have a high conviction, valuation-focused process which seeks to maximise exposure to companies I consider to be the most attractive.  I am not averse to deviating meaningfully from the benchmark which is why you will find that I have used the flexibility to invest a proportion of the portfolio overseas with a meaningful allocation to gold mining companies*.

* 16.7% End August 2020 across Barrick Gold, Newmont Mining, Agnico Eagle Mines and Wheaton Precious Metals.

I have held gold mining companies in the portfolio for around 3 years, starting with a small allocation that I have increased over time, particularly in the last 18 months.  In volatile equity markets they have worked well during the disruption sown by COVID-19, but their main function from a portfolio construction perspective is to protect against increasingly negative real interest rates. 

The economic issues we now face are being met by increased stimulus, monetary but - crucially - also fiscal, as governments spend more and more to protect jobs and support economic activity. This has widened fiscal deficits and driven money supply materially higher and inflation expectations have increased as a result. In a world of such low interest rates and bond yields, this has pushed real interest rates further into negative territory and is the main reason for the strong performance of gold itself.

In turn the shares in these gold mining companies have risen very strongly. Nevertheless, they have not kept pace with the increase in consensus earnings and free cash flow¹ (FCF) forecasts and so have de-rated into the rally resulting in free cash flow yields that are now in high single digits.  These valuations are at discounts to other shares in alternative “defensive” sectors that we would expect to prove less defensive over time. This further strengthens the rationale for these four holdings. 

The two biggest positions are in Barrick Gold (6%) and Newmont Mining (4%). Both are listed in North America, have similar market capitalisations of $53bn (USD) and have strong balance sheets.  They achieve geographic diversification across 4 continents and more than 15 countries, and diversification by asset across some 30 mines. The assets are at the low end of the cost curve (which makes them less exposed to fluctuations in the gold price making them more defensive) and have long reserve lives that can be maintained at 10 years within current capital expenditure budgets.

The companies have management teams of exceptional quality and experience. Both have strong capital allocation frameworks and have already completed successful mergers and acquisitions which means that an increasing proportion of the FCF mentioned above can come back to shareholders through dividends and share buybacks.  In our recent interactions, both have made it clear that shareholder distributions are likely to increase significantly. 

When it comes to Environmental, Social and Governance (ESG) this is front and centre for the mining industry and has been a key area in our assessment of the investment case and each of these companies has a strong track record.  Investors have pressed for improvement in how mining companies address issues such as climate change, water management, impact on local communities and health and safety for employees and the community.  Barrick and Newmont are acutely aware of the importance of these factors and have been actively engaged with investors on this subject for many years.

In 2019 Barrick acquired Randgold Resources.  The former Randgold assets are in central Africa where strong engagement and relationships with local communities are vitally important given the contribution the operations make to the social and economic development of the host countries.  Mark Bristow, the Randgold CEO, became CEO of Barrick and his long experience devolving responsibility to local management teams and maintaining strong relationships in-country over the years is invaluable to the sustainability of the enlarged business. 

Newmont proactively engages with external stakeholders of the business based on inclusion, transparency and integrity.  For example, the company operates mines in Australia, where they endeavour to work with communities to ensure that any adverse impacts on the indigenous cultures and history are minimised and improvements are made to local communities. 

There is always scope for improvement, whether it be mine safety enhancements through training, technology and automation, or reduced carbon emissions by shifting to renewable energy sources or electric vehicles at the mines.  Increased data gathering and analysis will assist in the accurate measurement of the performance of the company against its sustainability credentials and enable us to assess progress against their long-term strategies.  Improvement in ESG will be keenly watched by investors and those mining companies that successfully minimise potential problems are in the long run likely to benefit from a lower cost of capital.

The FCF yield is very attractive and although exposure to a commodity price brings inherent uncertainty, these two companies are best in class in so many ways that I believe they have the best risk profile in the sector.  This includes the strength of their balance sheets and their corporate governance structures, both of which are a significant focus for me when selecting companies for the portfolio.  

Invesco Perpetual Select Trust plc UK share portfolio is managed by James Goldstone and has four gold mining company holdings: Barrick Gold, Newmont Mining, Agnico Eagle Mines and Wheaton Precious Metals.  

¹ Free Cash Flow represents the cash that a company generates, after accounting for cash outflows to support operations and maintain its capital assets, which is available to pay to investors in the form of dividends and interest.