Lull in Fall Gold Rush Provides Good Buying Opportunity
Trend in reverse: Strong US dollar, calmer markets drive stocks down
Ian Karleff
Financial Post
Analysts say stock market volatility over the past six months and crumbling emerging markets have sparked interest in the shares of gold producers, but the jury is out on whether the rally is sustainable.
From the market's peak in April to its August low, the gold and precious metals subindex crashed 44.7%, far outpacing the 27.9% drop in the Toronto Stock Exchange 300 index.
Fears of a global recession caused by the collapse of emerging market currencies and a slowdown in corporate earnings contributed to the carnage. Once September rolled around and the dust settled, investors began looking for a safe haven; from Sept. 1 to Oct. 7 battered gold stocks soared 75% while the TSE 300 fell 1.2%.
The trend now appears to be in reverse with what the World Gold Council cites as a "stronger US dollar and calmer equity market conditions" driving gold stocks down 16.5% and the Toronto index up 9.8%.
And September's rush in to gold miners was accompanied by only a 9.2% rise in the price of gold bullion to $299.85 (US) an ounce.
Historically, a long-term investment in gold stocks, unless during a prolonged period of economic despair and inflation, is a losing punt. Over the past five years, the gold subindex has lost 8.3% annually, compared with a 7.9% gain for the TSE 300.
So why buy gold stocks now?
If you think the Middle East is ready to break into chaos, inflation about to soar, derivative disasters have only just begun, Asia's appetite for gold will increase, and central bank sales have stabilized, now is the time to buy. Also, gold stocks could be a good bet if you agree with the majority of analysts that the supply-demand fundamentals for the precious metal are improving. Over the past few years, uneconomical mines have been closed and according to precious metals statistics firm CPM Group Inc. in New York, estimated 1998 mine production will rise only 1.2% to 64.9 million ounces.
Total supply is estimated by CPM to be 101.8-million ounces, compared with industrial and jewellery demand of 104.7-million ounces. However, supplies outweigh demand if central banks sell an estimated 18.5-million ounces into the market rather than to other central banks.
Alastair McIntyre, director of Scotia Mocatta, says, "Everything is fairly optimistic for gold but what is hurting it, is central bank selling and low inflation."
The largest consumers of gold, India and the Middle East, have increased demand, albeit from depressed levels,and central bank selling is not expected to dramatically effect supply, says Mr. McIntyre. And while the performance of all gold stocks has a connection to the underlying price of the metal, they react differently based on market capitalization, hedging programs, and production costs.
Gold stocks with more than $1- billion in market capitalization such as, Barrick Gold Corp. (ABX/TSE) and Placer Dome Inc. (PDG/TSE) are the biggest Canadian producers in terms of market capitalization and make up 57% of the TSE gold and precious metals subindex. In September, those producers soared 51% and 69% respectively because investors shifted money into the most liquid stocks to hedge against equity market volatility.
Both have sold a significant amount of their future production, thereby limiting their exposure to fluctuations in the price of gold.
Douglas Cohen, gold analyst at Morgan Stanley Dean Witter Inc. said Barrick's stock would participate nicely in a gold rally while offering protection if gold struggles because the firm has locked in an average gold price of $400 (US) an ounce for 10 million ounces through hedging.
However, Barrick insiders in September were actively selling large amounts of their own stock at the $30 level, which could be construed as a bearish indicator.
For investors looking for a company with more leverage to the price of gold, Mr. Cohen recommends Newmont Mining Corp. (NEM/NYSE). The company's production costs of $200 (US) an ounce are at the midpoint of the large caps. Its reserves will grow with its property in Peru but at risk is its exposure to Indonesia, says Mr. Cohen.
"At the moment investors should look at mid-tiers and if [they] feel like it, go for a punt and go for exploration companies," said gold analyst Robert Van Doorn at Loewen Ondaatje McCutcheon Ltd. He is focusing on companies such as Goldcorp Inc. (Ga/NYSE), which rose 96% since Sept. 1, because in his opinion it is fundamentally too cheap.
Chad Williams at TD Securities Inc. also likes Goldcorp, which produces gold at $240 (US) an ounce and is developing a low-cost mine. He recommends investors look at established producers with attractive projects, low cash costs, large market capitalizations, clean balance sheets and solid track records.
Mr. Williams says to steer clear of exploration stocks. "It's difficult for them [exploration firms] to get any attention. Even if they produce results, people are leery of them right now."
One exception is Meridian Gold Inc. (MNG/TSE). Its shares have soared 82.5% this year, placing it in the top three performers on the TSE 300 and raising it to a mid-cap. Analysts are still rating it as a "buy", based on increased production from its northern Chile project, which should lower production costs to $220 (US) an ounce .
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