Also from Canaccord today... We recommend investors scale into any price weakness in gold equities as this may be the last
pause before a phase of accelerated relative price appreciation or mania begins.
Daily Letter Summary | 3
16 September 2011
PORTFOLIO STRATEGY
Portfolio Strategy | Martin Roberge, M.Sc, CFA, 1.514.844.3734
• Portfolio Strategy: Sector Rotation Insight -- Gold equities: calm before... the
mania?
The Denver Gold Forum has arrived. Time to sell? Next week begins the Denver
Gold Show. History shows that this period often coincides with an interim peak in
gold and gold shares before negative seasonality starts in October. We recommend
investors scale into any price weakness in gold equities as this may be the last
pause before a phase of accelerated relative price appreciation or mania begins.
Why?
• First, our gold reflation gauge remains bullish. This timing indicator blends key
variables influencing gold and gold stock prices. Above zero, the odds are about
two-thirds for the bullion to rise and gold shares to outperform the market.
• Second, book-based valuation of senior golds is cheap. At prior cyclical peaks,
world gold equities were overbought and traded at relative price-to-book ratios
between 2x and 4x. At 1.7x, there is much room for valuation expansion.
• Third, relative price strength is supported by relative EPS strength. Relative to
the world equity market, the gold sector has broken out to 52-week highs. This
push is corroborated by relative forward earnings and ROE trends.
• Fourth, payout ratios should increase markedly. Dividends of world gold
companies represent only 20% of their profits (1.5% of their free cash flows).
This is much lower than the historical average of 45%. The lukewarm reception
of recent acquisitions and investors’ appetite for yield argue for higher payouts.
• Fifth, conditions for a mania appear to be here. Aside from the 14% weight in
the S&P/TSX, excess liquidity, moral-hazard economics, extrapolation of false
assumptions and herding mentality are the ingredients to feed a mania.
• Our view of a possible mania on gold equities is subject to risk factors that we
classify into four categories: 1) Economics. A positive resolution is found to the
European debt/banking crisis and global quantitative easing measures are
halted. 2) Earnings. Capex and cost inflation accelerate and bite into profit
margins. Income. Companies are too slow to pass on higher gold prices to
investors in the form of higher dividends. And 4) Valuation. While gold equities
are cheap on most valuation metrics, the gold bullion is near/above its 1979
peak relative to other asset classes such real estate and industrial commodities. |
