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All that glitters - should be sold?

Created:

2 February 2010

Updated:

3 February 2010

Written by:

Daniel O'Sullivan

Now trading around $1,088 (£681) per oz, gold has dropped some 11 per cent since we called a top in the yellow metal after it touched $1,226 in early December. While many analysts think it will climb again from here in due course - see the accompanying broker view below - gold's rise does fit with the classic bubble, fuelled by speculative financial flows and at odds with fundamentals. Given that asset bubbles tend to deflate as dramatically as they have previously inflated, there is a risk of material downside to the gold price from here.

Gold panning

This bearish view is down to a combination of factors. The underlying physical market for gold, particularly the Indian demand that dominates trade in the yellow metal, has atrophied at gold prices above $1,000, and this has happened right through the peak in annual demand dictated by the Hindu wedding season. As we move toward gold's traditional summer doldrums, even the minimal support from this quarter is set to disappear. Meanwhile, despite the reams of commentary expended on the spectre of inflation, governments around the world know that in the near term the real danger actually remains a deflationary environment should they withdraw their various stimulus packages too soon.

Last but certainly not least, it seems clear that the boom in metals seen over the past year - base metals as well as precious ones - has been a function of a vast carry trade fuelled by investors funnelling cheap dollars into riskier assets. As the dollar strengthens with the nascent US recovery, comparative eurozone fiscal concerns and the increasing likelihood of the US authorities tightening up monetary policy, this carry trade is now unwinding. Risk assets, including gold, are falling as a result. So now seems an apposite moment to survey the handful of main market-listed gold miners and try to work out who might suffer the most from gold's decline.

Our table lists these companies alongside their share price, market capitalisation, consensus price-earnings ratios for the next reportable year plus the year after that and their percentage change over the last year. The final two columns add some statistically-derived data. The 'R-squared' number tells us what proportion of a share price's weekly movement can be 'explained' by the weekly movement in the gold price. Meanwhile the beta reflects the percentage the shares moves on average relative to a 1 per cent movement in gold.

Wheat and the chaff

One of the most obvious points is that these companies display some seriously divergent performances through a period in which gold itself gained 21 per cent. The obvious outperformer is Centamin Egypt, known as the company mining the 'Pharoah's gold' due to the fact that its Sukari project in Egypt taps a deposit identified on an ancient map almost 3,000 years old. The succession of happy events behind Centamin's 179 per cent gain is clear: in mid-2009 it announced its first gold pour from Sukari, by autumn it was transferring from the Alternative Investment Market (Aim) onto the main board of the London Stock Exchange (LSE), and in January it announced first exports from Sukari and confirmed the project was operating at planned throughput levels.

At the other extreme is Central Rand Gold, which has for several years been preparing to re-open some mothballed mines near Johannesburg, but for which 2009 turned out to be far from golden. The company was dogged by a nasty dispute with its slated Black Economic Empowerment (BEE) partner that called into question the development funding plan and timetable - cue the 65 per cent decline. Although Central Rand is carrying out trial mining, it has yet to commence commercial production, so it is the only company among our group lacking forecast earnings against which the shares can be valued.

Hochschild, Fresnillo and Petropavlovsk - the first two are both Latin American gold/silver miners, the third, the renamed Peter Hambro Mining, has operations focused on Russia - all managed gains in a roughly 80-100 per cent range. Randgold Resources, which until a few years ago was the only main market gold miner, turned in a more modest 47 per cent gain. There is an obvious reason for this, hinted at in Randgold's sky-high forward PE ratios. It has for a long time been extremely highly-rated, a reflection of its attractive West African asset base and growth profile plus well-proven management. This glaring premium has acted over the past year as a drag on the share price relative to lower-rated peers.

Yamana Gold, another miner exploiting a spread of deposits across Latin America, presents a conundrum. It is, in general, a well-regarded company with operations progressing on track and, moreover, an extremely low cost of production. It is also, according to our number-crunching, the play with the highest R-squared to gold and a punchy beta around 2 as well - yet overall, through the same period it shows an extremely nondescript 20 per cent gain. All we can say is that the other 44 per cent of share price movement the gold price does not account for must have seen other factors weighing on the stock considerably! There is one obvious candidate - around the middle of last year, Yamana dropped noticeably as it sold some properties and analysts complained both that it did not achieve a good price and had compromised its stated growth targets.