Gold stocks cheap while risks remain

Spot gold prices and the shares of major producers have taken a hammering during 2013, but the historic share price lows are renewing interest in resource stocks for some analysts, senior business reporter Simon Hartley reports.

Gold and producers of the precious metal have had a forgettable year, with some major stocks down about 60%, the spot gold price teetering near unsustainable margins, thousands of jobs lost and scarce cash available for capital investment.

While analysts are bullish on the outlook for spot gold prices and see resource stocks in general offering good value, the sector has some way to go towards making a full recovery.

Following gold's bull market run after the global financial crisis, with investors seeking safe-haven investments, the purse strings have since been loosened and appetite for risk and higher returns has increased, with cash flooding back to equities markets.

However, for the extraction and resource sector, China's wavering growth trends and some mineral stockpiles have been a disincentive for investors, who in many cases fled resource stocks, many having became overly encumbered with debt from the height of the metals commodities boom.

Announcements this week of the US Federal Reserve beginning to taper its economic stimulus pushed gold down to about $US1200, with expectations the US dollar will strengthen.

For many major gold producers to keep profit margins viable, they have had to target high-grade gold reserves and close their high-cost mines in an attempt to haul back production costs by about $US200-$US250 per ounce, to within a range of $US1000-$US1100.

During the past year or so, spot gold hit a high of $US1751 ($NZ2125) in November 2012 to low of $US1200 ($NZ1456) in late May, a 30% decline.

During this week (the week up to and including today) gold has been stubbornly at or below $US1200.

Over five years since 2008, spot gold had risen from a low of $US735 to hit a record $US1900 in late 2011, but in the following two years that decline equates to a 35% fall.

However, Craigs Investment Partners and Forsyth Barr analysts are turning their eyes to resource-sector stocks, and while still considered risky, offer some cheap buying worthy of scrutiny.

Craigs broker Peter McIntyre said while commodity prices were down slightly during the past three years, resource-sector stocks had underperformed by more than 30% and now looked cheap; being well placed to benefit from an upturn in the global economy.

''With banks' [stock] relatively expensive, we're recommending rotating into the resource sector,'' he said.

Key for the gold companies was them continuing to focus on cost reductions, minimising capital expenditure, paying off debt, use hedging only as a risk-mitigation tool and to increase transparency over the new ''all-in sustaining cash costs'' financial measurement tool, he said.

Mr McIntyre said the resource share price to equity ratio was below its long-run average, and low against the rest of the market.

''The improvement in the US and European Union manufacturing indexes suggests considerable scope for Chinese exports to rise further, adding to growth,'' he said.

He said key areas of growth in industrial production in China during the past year were ''solid recoveries'' of about 10% each in electricity, steel and cement, suggesting further growth acceleration in coming months.

Forsyth Barr broker Andrew Rooney said gold stocks had fallen from earlier peaks by 62% to trade at historic lows, but at share price to book value ratio, levels generally seemed at the bottom of the gold cycle.

''Gold stocks have fallen significantly as the market attempts to reflect the lower margins caused by lower gold prices,'' he said.

On the outlook for spot gold prices, Mr Rooney said with production costs having risen significantly it meant higher gold prices were required to maintain supply.

''Under this scenario we could see a significant rebound in the gold price over the next couple of years,'' he said.

However, for investors Mr Rooney cautioned that risks still exist in gold stock; that further mine closures could happen and that estimated gold reserve downgrades are inevitable, ''unless gold prices recover sharply in the near term''.

''While we would still look to mitigate these risks when investing, we feel investors are being well paid to buy risk and it now appears it is the right time to be contrarian,'' he said.

Mr McIntyre said spot gold's prospects were ''closely linked'' to interest rates in the United States, the strength of the US dollar and US equity risk premium.

''We believe headwinds for precious metal prices, and specifically gold, still lie close to the surface,'' he said.

With the Federal Reserve in recent weeks having signalled a delay to tapering, it had provided a ''less hostile'' interest rate and US dollar environments for gold.

''[However] we expect gold will continue to struggle to attract investor inflows in an environment where the US equity risk premium continues to decline,'' he said.

He said gold had not yet hit levels which could be considered ''cheap'' when compared with investing in equities or crude oil.

That value might be why there was continued ''lacklustre interest'' in gold ETFs (Exchange Traded Funds), with gold in ETFs having ''stagnated'' at 1950 tonnes during the past two and a-half months, he said.

Mr Rooney's preferred stocks include Eldorado Gold, Regis Resources and Franco-Nevada, but he was avoiding stocks which might be subject to reserve downgrades, such as Barrick, Newmont and Goldcorp.

Mr McIntyre's preferred resource stocks in Australia include Beadell Resources and Independence Group, Alacer Gold and Papillon Resources.

- simon.hartley@odt.co.nz

 

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