Will gold stocks shine for investors in the second half of 2002?
67 WALL STREET, New York--May 28, 2002--The Wall Street Transcript has published an in-depth (4,600 words) interview with David Mallalieu, Gold Analyst for Scotia Capital, which he examines the outlook for the sector and share specific stock recommendations. This interview is part of a 18-page Gold Stocks report featuring two leading analyst and two Gold Stocks sector CEO interviews and is available by telephoning 212-952-7433 or through The Wall Street Transcript.
TWST: How would you assess investment interest in gold, in both the metal and in the gold stocks through 2001 and in 2002 year to date?
Mr. Mallalieu: Let's look at the metal first, as that is the prime driver for the equity. Post-September 11, you saw a lot of enthusiasm for the metal. That was probably the crystallizing event for drawing attention to gold.
Gold metal interest continued on the back of concerns over the stability of the Japanese financial system - in particular, the introduction of a 10 million yen insurance coverage limit on bank time deposits. This culminated in small Japanese investors purchasing, according to the World Gold Council, about 40 to 50 tonnes of gold or the equivalent of between 1.3 and 1.6 million ounces of the metal. On top of this, we have had the spread of the Enron contagion to firms where we have always had heartfelt confidence in their stability, as well as escalating Middle East tensions and a weakening US dollar. All of these events have resulted in a positive sentiment toward the metal and that has translated into the leverage we have seen in the equities. However, the reality of the situation is that there actually has not been a great deal of metal purchasing, although there has been a great deal of metal speculation on the TOCOM and COMEX.
TWST: What does the supply/demand balance for gold look like as we move into the second half of 2002? Is demand still outstripping supply?
Mr. Mallalieu: Absolutely. I was just looking at Gold Fields Mineral Services data for 2001, and they are suggesting that fabrication demand was 3,500 tons in 2001 and primary mine supply was 2,600, so the supply/demand imbalance has continued to remain substantial.
How is this gap made up? It is made up through the central bank sales and from the recycling of scrap. Central bank sales accounted for slightly over 500 tonnes in 2001 and recycling accounted for slightly over 700 tonnes. So will we ever be in a situation where there is not enough gold? Not at all. However, with regard to primary mine supply versus the actual fabrication demand, we are definitely in a deficit, as we have been for the last decade. This is nothing new.
With regard to primary mine supply going forward, although Scotia Capital does not actually model all of the western world's mines, we have modeled a sufficient number - approximately 67% of world supply - to make good forecasts of where supply will be going over the next decade. Our numbers suggest that production will be relatively static in 2002, 2003, and 2004 versus 2001. We should see a decline in production that really begins to accelerate post-2005. You've heard people say that by the end of the decade, primary supply could be only 30% of what we have in 2002. If nothing changes, we believe that would be correct.
TWST: What are the implications of Barrick Gold's gold discovery in Peru?
Mr. Mallalieu: The Laguna Norte discovery in Peru, which is about 175 kilometers south of Pierina, is very important to Barrick Gold (NYSE:ABX - News). It is also important from the perspective of what the mining industry is doing, how it is evolving. It's quite curious that, apart from the Goldstrike discovery in the 1980s, this has really been Barrick's most significant discovery to date. The primary reason for that is because they have tended to rely on a robust junior exploration sector to provide them with a pipeline of deposits from which to augment their production profile. Apart from the acquisition of Homestake Mining, their last significant acquisition was Bulyanhulu in Tanzania via Sutton Resources. Bulyanhulu has turned out to have, at year-end, proven and probable reserves in excess of 12 million ounces of gold.
Laguna Norte is an excellent grassroots discovery. Barrick has suggested that its inferred resource is 3.5 million ounces, and we believe that they have been very conservative in their estimations. So is there room for them to expand this? It certainly looks like it. Does it look as if it could double in size? Quite possibly. We are being relatively conservative in how we treat this. There are only 45 drill holes that have been used in the resource calculation, which I believe is still insufficient, but it certainly looks very, very good.
If it does turn into a mineable resource and we do use costs similar to those which were applied to Pierina, we could easily see a value in excess of US$350 million. If the resource doubles in size, the impact would be to see more than a doubling of the value of the deposit.
TWST: David, notwithstanding the fact that you've told us that you're advising caution, are there any stocks in the group that you think investors should buy today?
Mr. Mallalieu: Absolutely. These are the ones that have not been on the forefront of the wave because they are either very low cash cost producers - meaning they don't have operational leverage or they don't have financial leverage.
For instance, Barrick Gold has generally underperformed since June; however, it has done an admirable job since the announcement of Laguna Norte. It has underperformed primarily because it has been perceived - and correctly so - as a hedger. At US$310 per ounce gold, 35% of the company's recoverable reserve base, ex-Laguna Norte, is hedged, and hedgers tend not to be the favored companies these days. The mantra of many gold producers - "we do not hedge, we will not hedge" - has found an audience these days. Providing that one is comfortable with a company that has shown hedging discipline in the past, I believe that there is room for further price appreciation in Barrick's stock, especially if one takes into account the recent discovery.
TWST: By the way, David, how have the gold funds performed over the past six to 12 months?
Mr. Mallalieu: The gold funds have done very well. There's no question about that. One should also consider them as the gold survivors. They've had a very arduous time since 1997. They've had cash outflows and their funds have shrunk substantially. They've had a very difficult time even when opportunities in the sector have become obvious. They have been faced with the conundrum of having to sell some of their better, more liquid holdings to purchase other equities, all in the absence of funds inflow.
For the generalist portfolio manager, Barrick Gold meets most of the investment criteria with regard to balance sheet safety, low cash cost, reserve growth, stable production profile and liquidity. With Barrick, a portfolio manager can have exposure to gold but also exposure to a stock with the lowest volatility of its peer group. This means that the manager need not be completely attuned to the nuances of the bullion market to still have confidence in his or her equity exposure.
This interview is part of a 18-page Gold Stocks Report and this interview is available through The Wall Street Transcript .
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