|Summary: The price of gold managed a brief rally during the week, before gold investors sold down the precious metal to recoup profits. Many gold producers are struggling to operate profitably in the new lower gold price environment, and their woes will be exacerbated if the metal sinks further.|
|Key take-out: For investors still keen on gold exposure, the metal retains its appeal as an insurance policy against risk. But owning physical gold is likely to be a safer bet than gold stocks, many of which are dogged with operational and cash flow problems.|
|Key beneficiaries: General investors. Category: Commodities.|
Gold is back on the investment agenda, but don’t expect too much too quickly from miners of the metal.
That is, unless they have a special case to argue such as a super-low production cost or because they are already trading below their cash backing.
The fact that there are some smaller gold stocks, such as Chalice Gold Mines (CHN), selling for less than cash in the bank is an indication of the negative overall sentiment in the market towards gold companies.
On the one hand Chalice, at 16.5 cents, looks to be a screaming buy thanks to the backing of 19c in cash generated from selling an African gold asset two years ago. It then banked the $55 million in proceeds, until management thought it time to make a return.
On the other hand, there are doubts about whether the company’s recent return via the acquisition of a small gold project in Canada has been made too soon in the gold-price cycle. Some gold watchers are expecting the price of the metal to continue falling, perhaps through the $US1,000 an ounce mark, even as other observers are tipping a price recovery back above $US1,400/oz.
The trouble with gold
The problem with gold is that there are always arguments in favour of an investor adding exposure (central bank money printing, global economic uncertainty, emerging market investors dumping their domestic currencies in favour of gold, and Chinese buying to name four), just as there are arguments against (global economic recovery, rising US interest rates, and severely bruised credibility after last year’s 28% fall in the gold price).
The damage done last year continues to reverberate through the industry, and while no-one has yet added up the total of losses incurred by mining companies it is highly likely to be more than $US50 billion.
Last week alone three North American goldminers, Barrick, Kinross and Goldcorp, revealed $US16 billion in losses for the 2013 calendar year and massive write-offs in their gold reserves. This was courtesy of the lower gold price, rendering gold in the ground worth billions of dollars uneconomic to mine.
Newcrest (NCM), the local favourite and easily Australia’s biggest goldminer, is a case study of the tug-of-war between believers and non-believers in the gold story – and gold really does come down to a question of belief rather than hard facts.
Just over two months ago (December 6) Newcrest shares plunged to a multi-year low of $6.96, thanks to a $6.2 billion asset impairment charge for the year to June 30. But there was an even more damning figure, with management reporting that the company would only be “free cash flow positive in the 2014 financial year at a gold price of $A1,450 an ounce”.
Newcrest has recovered from last year’s share price low, and some investors will have profited handsomely from speculating in Newcrest shares. However, in terms of investment appeal, the company is a shadow of its former self, especially when looking back to the gold boom year of 2011 when the stock hit an all-time high of $42.42.
To put Newcrest’s revived price into perspective, and using management’s own $A1,450/oz as the point at which the company becomes free cash flow positive, it can be said that the company is just scraping over its own barrier. It is generating a lowly $A15/oz using the latest gold price of $US1,312/oz, which converts to $A1,465/oz at an exchange rate of US89.5c.
Deutsche Bank, Citi and Credit Suisse retain sell tips on Newcrest despite the company last week reporting a $40 million statutory profit for the half-year to December 31. Deutsche is leading the negative side of the case, with a price target of $7.30, which implies a 31.5% price fall over the next 12 month.
Other banks are not so wary of Newcrest (or gold). J.P. Morgan rates the stock as overweight, with a price forecast of $12, but the overall consensus view of eight investment banks following the stock is “sell”. The collective 12-month price target comes in at $10.41, about 25c less than the latest price of $10.65.
Repairing damaged balance sheets
Newcrest is not the only player in the gold sector, but it is a leader and could become caught up in the next negative trend in the industry – capital raisings to repair balance sheets damaged by the price fall of 2013.
Several small gold stocks have recently called on investors for extra capital, including Perseus Mining, Unity Mining and Kingsrose. Perseus took advantage of the gold-price recovery to raise an extra $30 million. Unity is raising $5 million, and Kingsrose raised a fresh $8 million.
Another problem for investors with an appetite for gold is that the last year’s bruising has triggered a return to gold hedging, which essentially means locking in the best price possible today and generally forgoing any upside should the gold price recover.
The problem with gold is that while it will have its up-days (and weeks) there appears to be more downside pressure than upside with the US dollar (and US interest rates), gold’s greatest enemies, and with the US economy expected to continue its cheap-energy recovery, there is more chance of the dollar rising than falling.
What that means is that every time there is a bounce in the gold price, such as that which occurred last week, there will be “stale bulls” keen to take advantage of a short-term price recovery to trim their losses. Which is precisely what happened this week as gold was whacked with a correction that pulled it back from around $US1,327/oz to $US1,311/oz.
From a strict investment perspective, gold retains its appeal as an insurance policy against risk, especially the risk of governments unleashing inflation as they try to stimulate economic growth.
But, if that’s the argument for gold, then the only way to achieve the desired insurance protection is to own physical gold, either as bullion or a reputable bullion-backed product.
Some gold equities, especially after last year’s big gold-price correction, have the investment charm of a falling knife.