Gold stocks valued below spot price
Some producers trading as if metal is 10 percent lower
By Thom Calandra, CBS.MarketWatch.com
Last Update: 12:12 PM ET Mar 3, 2003
SAN FRANCISCO (CBS.MW) -- Not six months ago, gold miners were the stock
market's biggest money-maker. Now they're the new whipping boys.
Investors are treating mining companies as if the price of gold were 10 percent
lower than it actually is, says a veteran metals-watcher. This is a rare
occurrence in an industry whose share movements the past 18 months have
magnified gold's gains by a factor of three or more.
After a brisk gold run to almost $390 an ounce, bullion in recent weeks has
lost about 10 percent of its value. On Feb. 17, the metal's spot price touched
$341.50 an ounce, its lowest point since the 2002 year-end rally that took it
above $340. The metal, which attracts investors during terrorist flare-ups and
in economic crises, has lost ground in all major currencies.
Even the weekend capture of a notorious terrorist suspect in Pakistan may send
gold, hovering near $350 an ounce, down another 10 percent in coming weeks, say
the skeptics. Some short-sellers, primarily $100 million (and less) hedge
funds, are actively promoting gold-miner shares as doomed to lose 50 percent of
their value in the next six months.
On Monday, gold stocks were selling off sharply in all of the world's major
equity markets, down 3 percent and more to their lowest point since
mid-December. The spot price of gold in New York also was taking it hard, down
almost $4 to $345.80 an ounce.
Against this backdrop, say gold-bashers, the group facing the biggest risk is
gold-mining shares, in particular the highest-fliers whose market values
tripled and quadrupled in less than two years. That includes small exploration
companies such as Canada's Nevsun Resources (NSU), which last year was the
world's biggest-gaining gold share after its promising discoveries in the west
Africannation of Mali.
With swollen market caps, mid-sized companies such as Meridian Gold (MDG)
remain vulnerable even after a 15 percent drop since mid-December, say Wall
Street's gold critics.
The largest companies, among them Barrick Gold (ABX), are thought to be
susceptible to coming losses for a variety of reasons, among them dwindling
prospects for new discoveries, complex balance sheets and a looming wave of
insider selling.
In the face of that skepticism, veteran gold watchers are steadfast. Analysts
who have followed bullion since its heyday of the late 1970s and early 1980s
deliver what looks like a unanimous verdict: the gold rally is merely on pause
and will resume later this year.
John C. Doody, the dean of quantitative analysis for gold shares, says most
gold producers, large and small, are still incredibly cheap against a $350 gold
price.
Doody's is a number-crunching newsletter that sets the standard for the
bullion metrics of publicly traded mining companies. In it, Doody regularly
evaluates the miners based on their break-even market capitalizations -- the
average per-ounce price of their proven and probable reserves plus their cash
costs for the gold these companies actually pull from the ground.
When the total comes to less than the current gold price, a cheap gold stock is
born.
Doody says the gold producers whose shares are available to investors in North
America are selling as if gold were selling for $317 an ounce. Freeport-McMoRan
Copper and Gold (FCX), based on Doody's market cap-per-ounce premise. Using his
measure, Freeport's gold portfolio is valued by the stock market at just $57 an
ounce.
"There are many other issues to be considered, such as debt, projects in the
pipeline," Doody told me Monday morning from his office in Florida. "Meridian
Gold's Esquel, for example, has no proven and probable yet, but the stock is
priced as though the market thinks Esquel has 2 million to 3 million ounces."
Mine location is another variable. Is a promising deposit in a country, or a
state, where gold mining, is an established business, aided by popular opinion
and government regulations, like Canada or parts of the United States? Or is it
somewhere that holds great political risk, like Venezuela or Indonesia? "If
Freeport's mine were in Nevada, the stock would be $100," says Doody about
Freeport McMoRan's Papua, Indonesia, mine, the world's largest gold deposit.
Freeport shares sell for $17 each on the New York Stock Exchange.
Among the cheapest gold miners, according to Doody's valuation model, are
African miners Randgold (RANGY), Ahanti Goldfields (ASL), Gold Fields Ltd.
(GFI) and Harmony Gold (HMY). Canada's Eldorado Gold (ELD), Peru's Buenaventura
Mines (BVNOF) and Denver's Golden Star Resources (GSS) are also dirt-cheap,
Doody says.
Doody says his valuation model is a starting point for identifying undervalued
mining shares. "This is a very simplistic approach, but it's a method one can
use to start evaluating the gold stocks." The gold analyst is sticking to his
2003 forecast of a $450 gold price.
Others are just as convinced the gold rally is just taking a breather. One of
them, James Turk, had a February price projection of $430 an ounce for spot
gold's price. Turk uses monetary measures, including Federal Reserve-boosted
money supply levels, to forecast gold prices, which are influenced by the level
of the dollar, pace of inflation and the fiscal soundness of the world's major
economies.
Turk, speaking to me Monday from Toronto, says his a ratio of America's money
supply levels and the country's gold assets, indicates far higher gold prices
in the coming 12 months.
"Having missed February by such a large amount, one would think that prudence
dictates that I should revise my targets downward, but I haven't," Turk says.
"I'm sticking by my fear index, which remains bullish. When the euro starts
trading above $1.085, then look for the gold price to start rising again." The
euro Monday morning was worth $1.081 in American currency. See:
Global researchers say the strongest theme for the metal may be a shift by
countries, Russia and China among them, to reduce their reliance on
dollar-linked paper assets (mainly U.S. Treasury securities) as the main source
of their foreign reserves.
"In Russia, the deputy finance minister said dollar reserves should be cut to
50 percent from 70 percent, and gold reserves more than doubled to 10 percent,"
says Adrian Day, a Maryland fund manager.
First Deputy Finance Minister Alexei Ulyukayev's gold bulletin in Moscow rang
bells among commodity researchers, who generally credit central banks with
setting long-term trends in the accumulation and disposal of physical assets
such as gold.
James T.S. Tu, director of investment management and research at commodities
specialist Gerstein and Fisher in New York, says central bankers are becoming
convinced their dollar assets will decline under the weight of America's
record-high trade deficits and Washington's willingness to triple its deficit
spending in the next five years.
"They know the dollar will go down because of unsustainable deficits,
unrestrained money supply, a weakening economy and the terrorist/war threat,"
Tu tells me. "Central banks will be the biggest gold supporters." The increased
purchases of bullion will come from countries with large trade surpluses today,
such as China (2 percent reserves in gold and a $102 billion trade surplus with
the United States in 2002) and Japan (1.7 percent gold reserve). Resource-rich
countries that will benefit from a commodity boom, such as Saudi Arabia (7.3
percent gold reserve), also will increase their central-bank gold holdings, Tu
says.
Such countries' gold portions of foreign-exchange reserves fall far short of
those in developed countries. The United States has about 56 percent of its
foreign-exchange reserves in gold, France has 51 percent and Germany has 39
percent. "Central banks design policies that they stick to day after day, year
after year. They rarely change direction. Now they're moving away from dollars
and into euros and gold," says the Gerstein and Fisher director. "It will last
years."
One other positive development for gold could be the introduction of an
exchange-traded fund for the metal, says John Hathaway, manager of $215 million
Tocqueville Gold Fund (TGLDX). Several entities, including the World Gold
Council under the direction of Gold Fields' Chairman Chris Thompson, are
working with index-asset managers such as State Street Global Advisors to
sponsor a gold-backed ETF.
Such a security would amount to the QQQ of gold and trade real-time on a major
North American exchange, most likely the American Stock Exchange. The ability
to buy physical gold via a stock-market proxy almost surely would boost
investors' pen-up demand for the safe-haven metal, market watchers say.
For more on investing, see our Also: Thom Calandra on an explosive short-term
war rally. |
