"A 15th century gold bug who had stored all his wealth in gold bullion, bequeathed it to his children and required them to do the same would be more than a little miffed to see that the real wealth of his lineage declined by nearly 90 percent over the next 500 years"

A hate-hate relationship

I'll never forget my first job as a junior investment analyst at a leading international asset management company in SA. My mentor at the time said to me investing in gold companies is a bit like a "hate-hate relationship". You hate them when they go up and you hate them when they go down. He was referring to the relatively sharp gyrations, in between long periods of dismal performance, that gold stocks tend to go through.

Let?s reflect for a moment on how dismal the performance of the three gold majors has in fact been.

Barely beating inflation

Over the past 32 years the value of R100 invested in each of Gold Fields, Harmony and Anglo Gold would have barely beaten inflation. Over the same period an investment in an ounce of gold in dollars would not have done any better either, barely retaining its value in real terms.

There are several key reasons for the poor performance of the gold majors over the last 10-year period including that capital invested has far exceeded cash flows, gold production has declined steadily and the costs of extracting the gold have risen substantially.

Enormous shortfall of R43-billion

For instance, during the past decade, these "three majors" generated R69-billion in cash flows from operations. They invested R81-billion in new capital expenditure (mainly in property, plants and equipment) and a further R31-billion in other investments (acquisitions and gold price hedging structures). This leaves an enormous shortfall of R43-billion. This was funded by issuing shares to the tune of R35-billion and increasing debt by R20-billion.

Despite this large investment in new plants and equipment and further acquisitions, gold production declined by two percent a year for the above three companies. With current gold production at the lowest level since 1956, it?s not surprising that SA is no longer the largest producer of gold in the world ? that honour now belongs to China, followed by the US. Scientists found that SA?s Witwatersrand goldfields are around 95 percent exhausted and anticipate that production rates should fall permanently below 100 tonnes a year within the coming decade.

Returns worse than cash

All this has resulted in a Return on Invested Capital earned by gold companies over the past decade of below the after-tax return on cash. Simply put, the management teams of the big SA gold companies would have been better off putting shareholders? money in the bank rather than spending it on new projects.

Finally, gold companies have almost always traditionally traded at large premiums to their discounted cash flow value. This gap has narrowed more recently. But why would you want to own a company that trades at a multiple of what you think it is worth when you can invest in other companies that trade at a fraction of their fair value?

Sanlam Investment Management