As a result for many international investors the opportunity cost of holding a non-yielding commodity such as gold is markedly reduced when the alternative is to deposit cash in a bank account offering zero interest return and on which there is a holding tax. There is also the issue of supply and demand as central banks turned hefty buyers of gold in the second half of last year which was one reason why aggregate gold demand, despite being around its five-year average of 1,110 tonnes in the final quarter of 2015, exceeded supply of 1,037 tonnes by quite some margin. Central bank buying accounted for 167 tonnes of final quarter demand, well above the five-year average of 133 tonnes, driven by buying from Russia and China, in particular.
It will not have been lost on gold bugs either that the supply side is being constrained by a contraction in mine production, down by 3 per cent in the final three months of 2015, the first quarterly drop since 2008. These declines should come as little surprise. Mining companies' recent focus on cost-cutting had sown the seeds for much of this lower output, and reduced exploration budgets and project development has led to lower production from existing mines as well as a curtailed project pipeline. This, combined with longstanding issues such as lower ore grades, means it is likely that gold production will see declines over the coming quarters too.
In turn, a hefty rise in the gold price coupled with a sharp fall in sterling against the US dollar, the currency in which the commodity is traded, means that the gold price in sterling terms has risen by 24.3 per cent since the start of the year, or five percentage points more than the dollar denominated price.
Playing the gold price rally
Now this price action, and the industry supply demand backdrop, is of great interest to me because I included pawnbroker H&T (HAT:195p) as one of the constituents of my 2015 Bargain shares portfolio. The holding performed relatively well, producing a one-year return of almost 14 per cent in a down market. It’s worth noting then that the company managed to grow its pre-tax profits from £5.5m to £6.8m in 2015 on a modest 4 per cent rise in revenues to £47.5m even though the average gold price fell from £825 in January 2015 to a low of £712 in December last year. It’s now back to £895, and rising.
Clearly, when the price is under pressure this creates problems for companies like H&T as it reduces the gold margin earned from purchasing scrap and means that if pledges made on gold assets are not redeemed by customers, then it can be more difficult to recoup the loan made, and interest costs accrued, when the loan defaults and the item has to be sold. In contrast, a rising gold price reduces the possibility of losing money on a pledge given the underlying asset is increasing in value. It also entices customers to sell or pledge their gold assets given the more favourable price environment.
Bearing this in mind, H&T’s gross pledge book edged up slightly to £39m in 2015 and on which it made a flat pawn service charge of £28.4m. Total lending was £98m and 83 per cent of lending was either redeemed by customers, or renewed. So with the gold price rising sharply in the past few months then this should be good news for prospects for the pledge book to start growing again. It should also make selling pawnbroking jewellery more profitable too.
Earnings risk to the upside
And that's the major reason why I think that analysts may be erring on the side of caution by forecasting that H&T's revenues will be flat at around £89m this year. They do though expect a better operating margin which is why pre-tax profit is expected to jump from £6.8m to £8.2m to deliver EPS of 17.4p, up from 14.9p in 2015. Moreover, with the company degearing its balance sheet, net debt of £2m at the end of last year now accounts for less than 3 per cent of shareholders funds of £94m and is well within a £50m four year credit facility, so the company has ample funds available to boost pawnbroking lending volumes.
H&T is also well placed to expand its new business lines including a personal loans product that earns an average yield of 68 per cent on advances made. The loan book here is £4.2m or roughly 11 per cent of the pledge book, but it's growing fast.
I would flag up too that H&T pays a decent income, having hiked the payout per share by two thirds to 8p last year, a dividend that was far higher than analysts had anticipated. Andrew Watson at brokerage N+1 Singer is predicting a payout of 8.6p a share this year, implying a prospective yield of 4.4 per cent, and one covered twice over by forward earnings.
The bottom line is that prospects for another sharp hike in earnings is simply not priced in given H&T's shares are only rated on 11 times forward earnings and trade 25 per cent below book value. And if the upturn in the gold price continues, then the risk to earnings will be firmly skewed to the upside. Furthrmore, H&T can capture more of the profitable upside given that one third of all the outlets operated by the major groups in the alternative credit market have closed since December 2013. This reflects both the impact of the lower gold price, which is still down by a third on the highs of $1,921 per ounce in 2011, and the new FCA standards on high short-term credit lending which have driven many businesses to the wall.
On a bid-offer spread of 192p to 195p, valuing H&T's equity at £70m, or 25 per cent below net asest value of £94m, I continue to rate the shares a recovery income buy.
Please note that I have published two columns today, and one yesterday, all of which are listed below.
MORE FROM SIMON THOMPSON...
I have written articles on the following 80 companies since the start of this year:
■ Grainger: Buy at 243.5p, target 280p; Dart: Take profits at 580p; Crystal Amber: Hold at 159p; Redde: Take profits at 203p; Burford Capital: Run profits at 196.5p; Renew Holdings: Run profits at 404p; Plethora Solutions: Speculative buy at 4.5p ('Stock check', 5 Jan 2016)
■ Elegant Hotels: Buy at 118p, target price 130p to 135p ('Check in for a profitable stay', 6 Jan 2016)
■ Safestyle: Run profits at 272p ahead of pre-close statement on 25 Jan 2016 ('Clear cut gains', 6 Jan 2016)
■ Epwin: Run profits at 143p, new target 170p ('Epwin on the acquisition trail', 6 Jan 2016)
■ GLI Finance: Recovery buy at 37.5p ('GLI shelves fundraise and its chief executive', 6 Jan 2016)
■ LXB Retail Properties: Buy at 97.5p, new six-month target 120p; Urban&Civic: Buy at 286.5p, target 325p; Conygar: Buy at 172p, target 200p ('Hot property, 7 Jan 2015)
■ Somero Enterprises: Buy at 139p, target 185p; 1pm: Buy at 70p, target 82p; First Property: Run profits at 53p; Avation: Buy at 145p, target 200p ('Small-cap value plays', 11 Jan 2016)
■ 32Red: Run profits at 147p; Netplay TV: Buy at 7p ('Chipping in', 12 Jan 2016)
■ Cambria Automobiles: Buy at 87p, new target 95p; Vertu Motors: Buy at 76p, target range 85p to 90p ('Motoring ahead', 12 Jan 2016)
■ Global Energy Development: Hold at 24p ('Cash rich, but unloved', 12 Jan 2016)
■ KBC Advanced Technologies: Bank profits and sell in the market at 183p ('Tech watch, 13 Jan 2015)
■ Sanderson: Buy at 75p, target range 85p to 90p ('Tech watch, 13 Jan 2015)
■ Trakm8: Buy at 300p, new target 400p ('Tech watch, 13 Jan 2015)
■ Amino Technologies: Buy at 120p, new target range 155p to 160p ('Amino has the ammunition', 14 Jan 2015)
■ easyHotels: Buy at 89p, initial target 100p ('easyHotels ramps up expansion', 14 Jan 2015)
■ Stanley Gibbons: Hold at 58p ('Stanley Gibbons fundraise', 14 Jan 2015)
■ Miton: Buy at 28p, target 35p; Moss Bros: Buy at 97p, target 120p to 130p; Bioquell: Buy at 140p, minimum target 170p; UTV Media: Trading buy at 184p ('An awesome foursome', 18 Jan 2015)
■ Equity market strategy ('Bear Market signals', 25 Jan 2015)
■ STM: Buy at 47p, target 80p; Stadium: Trading buy at 103p; Fairpoint: Run profits at 150p, target range 200p to 220p ('Exploiting market anomalies', 1 Feb 2015)
■ Character: Buy at 505p, target 600p; 1pm: Buy at 67p, target 82p; and Entu: Hold at 68p ('A trio of small-cap plays', 2 Feb 2016)
■ Inland: Buy at 83p; Henry Boot: Buy at 220p, target 260p; FTSE 350 housebuilding sector: Trading buy ('Playing the housing market', 3 Feb 2016)
■ Flowtech Fluidpower: Buy at 109p ('Undervalued and ripe for a re-rating', 4 Feb 2016)
■ Safestyle: Run profits at 253p ('Awaiting news on a cash return', 4 Feb 2016)
■ Bowleven; Volvere; French Connection; Bioquell; Juridica; Mind + Machines; Oakley Capital; Gresham House; Gresham House Strategic; Walker Crips ('Bargain shares', 4 Feb 2016)
■ AB Dynamics; Inspired Capital; H&T; Netplay TV; Mountview Estates; Crystal Amber; Arbuthnot Banking; Record; Pittards; Stanley Gibbons ('How the 2015 Bargain share portfolio fared', 4 Feb 2016)
■ IS Solutions: Buy at 120p, target 150p ('Big data, big profits', 8 February 2016)
■ 32Red: Run profits at 133p, easyHotel: Run profits at 99p; Burford Capital: Run profits at 230p; Bilby: Buy at 136.5p ('Hitting record highs', 9 February 2016)
■ BP Marsh & Partners : Buy at 157p, new target 190p ('Primed for investment gains', 10 February 2016)
■ Gama Aviation: Hold at 270p ('Gama hits guidance', 10 February 2016)
■ Bloomsbury Publishing: Buy at 150p, target range 175p to 185p ('Book into a trading play', 11 February 2016)
■ PV Crystalox Solar: Speculative buy at 8.2p ('Lights brighten at PV Crystalox Solar', 11 February 2016)
■ Alpha Real Trust: Buy at 80p, target 105p ('High yield property play', 15 February 2016)
■ LMS Capital: Buy at 68p; Leaf Clean Energy: Await news on Invenergy; Eurovestech: Sell at 7p ('Investment company watch', 16 February 2016)
■ GLI Finance: Buy at 31p ('GLI Finance review offers potential for gains', 17 February 2016)
■ Trifast: Buy at 112p, target 140p ('Engineered for a higher rating', 17 February 2016)
■ 600 Group: Sell at 10p ('600 Group warns', 17 February 2016)
■ Marwyn Value Investors: Buy at 190p ('Undervalued, cash rich investment, 18 February 2016)
■ Henry Boot: Buy at 220p; Moss Bros: Buy at 102p, target range 120p to 130p; Creston: Sell at 103p; Minds + Machines: Buy at 8.5p ('Changing places', 22 February 2016)
■ CareTech: Buy at 245p, target price 300p ('Asset backed, lowly rated property play', 23 February 2016)
■ WH Ireland: Buy at 90p, medium-term target 120p ('WH Ireland hit by FCA fine', 23 February 2016)
■ Stanley Gibbons: Sell at 44p ('Stanley Gibbons rescue equity raise', 23 February 2016)
■ Gresham House: Buy at 325p ('Gresham House spruces up forestry deal', 24 February 2016)
■ Avation: Buy at 140p ('Aircraft deliveries mask Avation's lift off', 24 February 2016)
■ Tristel: Take profits at 125p ('Investors spooked by bugbuster's sales slowdown', 24 February 2016)
■ Town Centre Securities: Buy at 305p, target price 350p ('Property income play with capital upside', 25 February 2016)
■ Capital & Regional: Buy at 60.25p, target 66.5p to 70p ('Short-term trading buy', 29 February 2016)
■ Cambria Automobiles: Buy at 83p, target 95p; Vertu Motors: Buy at 71.75p, target 85p to 90p ('Lowly rated car dealers motoring back', 7 March 2016)
■ Sanderson: Buy at 80p, target 90p ('Tapping into cloud based profits', 8 March 2016)
■ H&T: Buy at 195p ('A golden opportunity', 8 March 2016)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful W
