Minefield: The dollar's golden glow

PORTFOLIO POINT: A lower dollar could add more shine to four gold stocks: two with projects in Australia and two with a South American focus.

With every man and his dog tipping a fall in the value of the Australian dollar, perhaps substantially, it is getting awfully hard for investors to continue to ignore the lure of gold, whether you believe it is at a peak in US-dollar terms, or not.

That’s why this edition of Minefield will focus solely on gold stocks: one which has been a regular, two which are new, and a fourth which is both new and a wild card.

The common themes linking all four are currency values as well as gold itself, and the thoughts of well-informed observers of financial markets; the investment bank, Morgan Stanley, our own Robert Gottliebsen, and the Governor of the Reserve Bank, Glenn Stevens

Stevens, in keeping with the cautionary approach of all central bankers, merely noted last Tuesday when the dollar was trading at US$1.04 that it was “a little on the high side” – as close as he dare come to a future exchange rate tip.

Morgan Stanley was more opinionated, telling clients a day later that the Australian dollar was shaping as a “big loser” in 2013, dropping to around US90c as China’s economy shifts from commodity-intensive to consumption driven.

Gottliebsen was the most alarmed writing, after listening to Stevens, that the Australian dollar could be heading back into the cellar with a possible fall to US50c by 2015.

With an exchange-rate decline becoming more certain, it’s worth considering what that does to the gold price on conversion to Australian dollars.

If the Stevens measurement of “a little on the high side” means a return to parity, then the Australian gold price will rise from its current $1671 an ounce to $1737, or by around 4%.

If the Morgan Stanley US90c tip is accurate, then the Australian gold price rises sharply, to around $1930/oz.

If Gottliebsen’s worst-case scenario of US50c is on the cards in the next few years, then gold simply doubles to more than $3400/oz.

The currency factor, which ought to have a place in most investment portfolio considerations, is critical when it comes to gold, thanks to its role as both a commodity and a currency. Right now there are two forces propelling gold higher – a potential fall in the Australian dollar and a potential future rise in the US gold price as global uncertainties refuse to fade.

Until now most Australian goldminers have failed to react convincingly to a US-dollar gold price that is high historically though struggling to climb far above US$1800/oz, or stay there thanks to profit taking.

Next year, if the currency effect kicks in, Australian gold stocks could have a bumper year. And while the entire sector is probably due for an uplift, there are a few ideas below with rankings assigned a colour coding: green for highly-rated and amber denoting a stock worth further research.

Northern Star (NST)

One of the strongest performers among local gold stocks over the past two years, Northern Star might be getting set for a second upward surge thanks to confirmation that it will be boosting production from its existing Paulsens mine, and developing a second mine.

At Paulsens in the Pilbara of Western Australia, a region normally associated with iron ore mining, production has been rising towards an annual target of 100,000 ounces of gold at a gross profit margin of more than $1000/oz.

High grades are the key to Paulsens which enabled Northern Star to lift its profit last financial year by 57% to $34.1 million, and pay a maiden 2.5c a share dividend.

Concerns held by some investors that the stock is a one-trick pony have been fading as exploration close to the existing underground mine has boosted reserves, while exploration at another prospect has confirmed plans for a second mine and processing centre.

The Ashburton prospect, also known as Mt Olympus, was once mined by another company, Sipa Resources, with limited success. Northern Star’s drilling has confirmed the potential of the area to support a second 100,000 ounce-a-year mine, taking the combined output to 200,000 ounces a year.

Details of the capital and operating cost of the Ashburton development are yet to be revealed, but Northern Star management has been very cost conscious at Paulsens, replacing contract services with its own mining team, which has lowered the cost-per-tonne mined by 20%.

Managing director Bill Beament said last week that the latest drilling at Ashburton had produced “pivotal” results for three reasons.

“They reveal there is substantially more gold at Mt Olympus than previously demonstrated, they highlight the significant scope to find a lot more, and they show our plan to double the company’s production by building a 100,000 ounce-a-year operation at Ashburton is moving rapidly towards fruition,” he said.

The last time Minefield looked at Northern Star was as recently as June 19, when it was trading at 91c. Last week the stock hit a 12-month high of $1.57 and has more recently been trading at around $1.53, with the rapid rise potentially putting off some investors.

That cautious view misses the point that Northern Star is a particularly well run company. It is focused on keeping costs down. It has started paying dividends, and has a plan to expand production into a gold-price environment that could deliver a double-whammy effect thanks to the US dollar gold price staying high (or rising) and the Australian dollar delivering a second win.

Cleveland Mining (CDG)

Low profile but well connected, Cleveland’s strongest asset is not its gold and iron ore assets in Brazil but a management team that has a lot to prove after high-profile careers with other mining companies.

One way of looking at Cleveland is as a mini-Fortescue Metals, with three of the five directors having served in senior positions at the Andrew Forrest-led WA iron ore miner.

Managing director David Mendelawitz was once head of business improvement at Fortescue. Russell Scrimshaw is a former deputy chief executive, and Jim Williams a former head of mining. Cleveland’s chairman is Don Bailey, a former deputy managing director of Rio Tinto and co-founder of LionOre, which was snapped up by Russia’s Norilsk Nickel in 2007 for more than $6 billion.

Whether the former Fortescue men can replicate what their former boss has done in building Australia’s 19^th biggest listed company is one reason to brush up on Cleveland. While that is possible, a degree of caution is required because other high-profile Australian boards have flopped in South America. These include gold hopeful Mundo Minerals, which started with a big board but failed to fire.

Cleveland’s plan is to start generating cash flow from gold. A first step in that direction was taken last week with the start of commercial production at the Premier mine in central Brazil. Small, but potentially quite profitable, the mine is expected to grow to an annual output of 40,000 ounces from next year, with cash from gold underwriting the development of iron ore production.

Investors, so far, have not warmed to the Cleveland story, cutting the stock back from a mid-year high of 95c to recent sales at 39c despite another interesting corporate connection via the Australian iron ore miner, BC Iron, taking a 5% stake in the stock.

With so many big reputations riding in Cleveland it is reasonable to assume that the current price might be the low point, with a re-rating possible as cash flow from gold grows and expansion plans are revealed.

Orinoco Gold (OGX)

Another South American-focused gold stock, Orinoco is starting from a low base and planning to grow.

Principal asset is the Curral de Pedra mine in southern Brazil, one of three gold assets in the company, which recently changed its name from Strickland Resources.

High grades are the key to Orinoco’s mining plan, which received a boost last week when the company reported the extraction of a maiden, one-tonne, bulk sample from old workings at Curral de Pedra, and deeper drilling success in the Cascavel zone of the mine.

The sample, said to be non-selective, assayed 22.1 grams of gold a tonne, which management said highlighted the “high-grade nature and significant potential of the rapidly emerging project”.

More work is required to see whether the grades can be maintained as Orinoco digs deeper into the mines it has acquired, and whether modern mining techniques can do better than what has been achieved in an area with a goldmining history that dates back more than 300 years.

Followers of emerging gold exploration stories have taken a liking to Orinoco, last week lifting its shares to a 12-month high of 42c, before the stock eased back to around 39c.

Doing business in Brazil is never easy, but like Australia there is a currency effect at work with the country’s president, Dilma Rousseff, last week echoing Australia’s Reserve Bank Governor, Glenn Stevens, in declaring her country’s currency, the real, to be “over-valued” against the US dollar.

A higher US gold price would help Orinoco, but so would a lower real.

Bullabulling (BAB)

If any company is going to benefit from a fall in the value of the Australian dollar it is Bullabulling, a business which emerged this year from the merger of ASX-listed Auzex and London-listed GGG Resources.

That messy ownership structure was overcome with the creation of Bullabulling, which owns a mine of the same name some 70km west of Kalgoorlie in WA.

Previously worked by Resolute Mining, Bullabulling has yielded 370,000 ounces of gold but was mothballed in the mid-1990s when the gold price was around US$350 an ounce.

In theory, developing Bullabulling should not be hard. It is well located, close to services and has a world-class resource in place of 3.4 million ounces.

In practice it will be harder than it looks because the ore is very low grade, assaying around 1 gram to the tonne. This means a large tonnage must be mined to achieve the economies of scale required to make a profit.

The current plan is to spend between $297 million and $333 million on a mine producing around 200,000 ounces of gold a year for a minimum of 10 years at a high cost of $1100/oz.

It is the cost per ounce that is putting investors off Bullabulling. But if the predictions of an exchange-rate fall are correct the timing of the project could be quite interesting, with capital equipment due to be procured soon at a high exchange rate and gold production starting in 2014 when the Australian gold price could be a lot higher than it is today.