Gold portfolio takes a bath
Recommendation
Prepare for volatility. That was our edict on 06 Nov 13 when, in AU, check out this gold portfolio, we recommended four junior miners as Speculative Buys. Never has being accurate been so unsatisfying. The four miners recommended – Northern Star, Silver Lake Resources, Kingsrose Mining and Beadell Resources – are down an average 20% within a month. Silver Lake has fallen more than 35% in that time.
Yet those falls disguise the extent of the volatility. Daily movement of 15% or more have been normal; a day that doesn’t inspire a 5% share price move is a quiet one. With all four stocks following the gold price lower, is it time to chalk this up as a mistake and move on? Is it time to sell?
The desire to sell is understandable. Gold is on the nose. Everyone agrees that quantitative easing will be ‘tapered’ as todays extraordinary monetary policy returns to normal. Everyone agrees tapering is bad for gold. No one knows by how much. So the gold price has suffered its swiftest decline in decades and gold miners suitably punished. The herd has spoken. In such circumstances contrarians and value hounds thrive.
Key Points
- Gold prices continue to fall
- Stock prices have followed gold lower
- For those seeking exposure, now is the time to act
Every investor has to make their own decisions about the risks they are comfortable with and there is an awful lot to consider when taking the plunge in a gold miner. The industry has historically been a capital sink, swallowing huge amounts of capital for little cumulative gain. For those who subscribe to the idea of a price for everything, however, now should be a moment of opportunity rather than fear.
The time to act
If extreme volatility causes you palpitations and losing money is unacceptable, gold miners aren’t for you. That’s fine, there are plenty of ways to make money without taking this particular bet. But if you have decided to speculate in gold miners, now is a time for action.
Remember we are buying precisely because gold miners are unpopular. Simply because we decide to stump up cash to buy a few of them won’t change that fact. Speculators be warned: gold stocks may remain unpopular and prices may continue to fall even after you have decided to buy.
Falling stock prices are due to falling gold prices. The Australian dollar gold price has fallen from highs of almost $1,900 last year to around $1,300, close to the marginal cost of production. As you can see from Chart 1, that still marks gold prices as historically high. So why are miners struggling now more than earlier?
Costs in the industry have exploded. In part, this reflects the wider resources boom but gold miners themselves deserve most of the blame. Miners have responded to higher prices by chasing more marginal projects, driving up their production costs.
Marginal costs across the industry have risen from about $400 an ounce 10 years ago about $1,200 an ounce today. High costs ensured lower production and lower margins when gold prices fell swiftly and savagely.
Diversifying risk
This is particularly true of Silver Lake. Falling gold prices have a proportionately higher impact on its profit because it is a higher cost producer. Yet with a gold resource of more than 6m ounces, ample processing facilities and multiple mines, production and margins could rise substantially if gold prices move higher. It is, in other words, highly leveraged to prices. Today that is a weakness which explains why the stock has fallen. If gold turns, it will prove a strength.
As well as our favoured four, two other miners have popped onto our radar. Ramelius Resources is small, high cost and highly risky. It may go under if prices stay low – output is currently marginal – but could make far higher profits with small price increases. Industry giant Newcrest is also approaching interest. The company carries significant debt of over $4bn and has large capital expenditure requirements to meet. We’ve long argued the business should shrink. It may soon be forced to. Neither is yet on our buy list although we are keeping watch. |
Although it garners most attention, price is but one risk in mining gold. Other risks such as regulation, geology, operations and financing are all vital in success.
In opting for a portfolio approach, we aim to diversify risk these risks. Each miner in the portfolio is deliberately selected because it is exposed to different types of risk. Silver Lake is exposed to greater price risk; Kingsrose is more exposed to political and geological risk; Northern Star to exploration and development risk and Beadell faces significant development risk. Over time, we hope diversity will overcome uncertainty.
Spec. Buy up to | Hold up to | Sell above | |
---|---|---|---|
Silver Lake Resources | 1.40 | 2.80 | 2.80 |
Kingsrose Mining | 0.80 | 1.60 | 1.60 |
Beadell Mining | 1.10 | 2.00 | 2.00 |
Northern Star Resources | 0.90 | 1.80 | 1.80 |
Yet there will always be uncertainty. As we explained on 06 Nov 13, predicting the gold price is folly. We buy gold miners not because they are good businesses – they are almost always bad ones – but for exposure to the gold price. When gold falls, equity prices will follow. That is a good thing because, if gold prices turn, leverage becomes a boon. That is the outcome we buy for.
With no operational changes, our four pronged gold portfolio remains a SPECULATIVE BUY for 5% of a risk tolerant portfolio.
Note: The Growth portfolio owns shares in Silver Lake Resources.