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It's Still a Miner Issue...But, It Could Be Major

By Jon Nadler       Printer Friendly Version Bookmark and Share
Feb 27 2009 3:06PM

www.kitco.com

Good Afternoon,

A fifth day of declines brought gold prices to nearly 9% under last Friday's $1007 peak, and sent speculators wondering about whether the 'correction' label still applies to this week's action. On the other hand (there is always that other hand) the metal averaged a monthly price in February, which has not been as high since last year's final tally in March. Very little to complain about, as far as that goes. The fear premium remains in place, for now. However, the metal might find it to be more of a reasonable/sustainable such surcharge at values nearer $870 - $880, in line with 2008's average price.

New York spot dealings ran into waves of long liquidation as the dollar touched above 88 on the index and as oil gave back 1.60 dollars from recent gains. Pre-weekend book-squaring and outright frustrated long sellers contributed to the decline, which at one point brought prices to $926 basis the spot bid. Support levels may emerge at or near $915 and/or $905, but much depends on how next week's perceptions of the crisis shape up. Silver inched closer to $13.10 in the afternoon hours, and platinum gained $15 to finish at $1067 per ounce. Palladium was a non-event for the day, ending at $194.00 per ounce.

Today's perceptions were largely defined by the brutal 6.2% contraction seen in the US economy - a number that harks back to the recessionary environment last seen around...1982. The CRB index fell nearly 2% on the grim news. The quest for dollars revived, and little else besides it. At least for today. The Dow was still in negative territory, you could still pick up Citi stock for $1.52 or so (if you had the guts), and US consumer sentiment was still best described in terms of expletives.

Perhaps gold is not yet in a bubble, perhaps it is not making a double-top, and perhaps it has not seen its highest level for the year. However, the amount of fickle, speculative money that remains visible in the market at this pivotal stage in the global financial crisis should give those who are clearly overloading their asset basket percentages with the metal, reason to stand back and ask themselves: "What happens if the sky remains in place?" or "What happens if conventional wisdom is in error?"

At least as far as some speculative fund money is concerned, I think we likely know the answer: "On, to the next best thing. Whatever that might be." Anyone with a reasonable amount of wealth to protect should own a modicum of liability-free gold. But, that is not the same thing as concluding that everything else should be absent from the portfolio. That mistake has been made with real estate, many a stock, and yes, with gold as well, in previous re-runs of Armageddon. The trick is to stay ahead, as bubbles do not have a way of deflating slowly, once pricked.

Cyclical investment demand is just that: transitory. However, the underlying market must still exhibit vibrant fabrication demand, no exponential offloading of scrap metal, and mine supply shrinkage rates much larger than 1 or 2 percent p.a., in order to remain at relatively high levels when (not if) the anxiety premia dissipate. Thus far, at least two out of the three potential price drivers shows little in terms of tendency to change course. India imported no gold in February. Yes, you should worry about that. A year ago, the country imported 23 tonnes, and even that was half-to-a-third lower than what it ought to have imported based on historical precedent. Scrap supplies are still on the rise. Yes, you should also worry about that. Minor issues to some, the above. They see only investment demand as the cure-all for the market. And now, for a...miner issue.

In the gleaming office towers of Vancouver, the great debate continues as regards the topic of mining company stock performance (the lack thereof, to be more precise) versus that which the companies are digging for. Fully one year ago, we had heard that the 'great switch' was upon us: it was time to sell the metal and buy the shares. Well, anyone whose portfolio contained an assortment of mining equities can tell you what actually happened in 2008. You may not want to hear the gory details, but tell you, they will. Thomson Reuters' reporter Dominic Lau finds that -once again- market watchers are signaling the flipping of the switch. Fortunately, as the article concludes, there might be room (and a strategy by which) to satisfy both camps:

"The price of gold might again be testing record highs, driven by investors seeking shelter from the financial blizzard, but shares in companies mining the precious metal now look a better bet. With financial markets tumbling and currencies crumbling, investors have fled to gold as a traditional safe haven in times of trouble, and as a bulwark against the long-term inflationary effects of massive and various government stimulus packages and monetary easing by central banks.

However, there may not be much upside left in the yellow metal, as the appetite for jewellery, which accounted for nearly 60 percent of global gold demand last year, falls in step with the slowing global economy. Shares in gold miners, however, have not kept up with the metal's prices and should do well, despite the volatile stock markets, for investors with a high risk tolerance.

"You're likely to have better performance in the equity, because it has lagged, and there is not much catalyst for the upside in the gold price itself," said Bradley George, fund manager and head of global equity resources at Investec.

George said he expected gold to trade within a range of $930 to $1,050 an ounce, with the upper end capped by weaker jewellery demand and the downside supported by safety-first investors looking to preserve cash. Spot gold, which traded at $939.85 an ounce on Thursday, has risen 40.6 percent in the last 18 months as the financial crisis has developed, including a 7 percent rise so far this year. By contrast, the gold and silver index, which comprises major U.S. and Canadian gold mining stocks, has fallen 13.5 percent in that period, including a fall of 4.7 percent this year, and despite a surge of 83 percent over the last four months.

Frank Holmes, chief executive of fund manager U.S. Global Investors, expected companies with strong financial discipline and no hedging, such as Royal Gold and Randgold Resources , would outperform gold prices. And that is despite the fact that Randgold is already sporting a one-year forward price-to-earnings ratio of 37.2, and Royal Gold is trading at 59.7 times, compared with the gold and silver index's multiple of 24.1.

Investec's George said he favoured gold producers that have their cost in a depreciating currency, such as those in South Africa, Australia and Canada. He prefers AngloGold and Gold Fields, for example, and said Randgold and Yamana Gold looked interesting. According to Reuters data, AngloGold carries a forward P/E of 17.9 and Gold Fields' stands at 21.

Ian Henderson, fund manager of JPMorgan Asset Management's Global Natural Resources Fund, said stock selection was always the key. "In recent years production costs have crept up, and for many growth has stalled. Investors have eschewed corporate risk, but ultimately you can't get away from the linkage of gold mining shares to the gold price," Henderson said.

However, he added gold miners' shares had done well relative to other sectors, and that Canada's Kinross Gold and Australia's Newcrest Mining had outpaced the metal since the end of October 2008. Production costs, mainly energy and steel, have come down for gold miners, helping boost their margins. Among Henderson's top picks of gold miners are Kinross, Lihir Gold, Barrick Gold, Newmont Mining, Kirkland Lake Gold, Peter Hambro Mining, Gammon Gold and Moto Goldmines.

U.S. Global Investors' Holmes warned the volatility of gold mining shares was far greater than bullion, however, adding that for every 1 percent fall in the price of gold, gold miners' shares would fall 3 percent. Holmes, who recommends investors hold 5 percent of their portfolio in bullion and another 5 percent in gold miners, also said the gold price could correct in the short-term but has the potential to rise to $1,500 an ounce.

UBS was also wary that a bear-market rally in equities could see a fall in the gold price, citing large, long gold positions on New York Mercantile Exchange's COMEX. But with the bleak economic outlook casting gold as an insurance policy for some time to come, many investors will want to keep up their premiums.

"If you are looking at more from a capital preservation point of view ... then I would go into the gold commodity," Investec's George said."Whereas if you are looking for some actual performance and you are prepared to tolerate the risk and the volatility in the equity market, then I would look to some of these gold producers."

Anyone wishing to hear more on the subject from our good friend Frank Holmes, can do so by 'attending' a special webcast on these and related issues, coming up next week. The question, of course, is whether both the metal and the shares can somehow converge, and add 50% or more to current values. It appears that the shares stand a greater chance of such an outcome -based both on some current values, as well as on the eventual economic recovery around the world. But, that only our opinion. To hear the webcast, you might wish to register at this link:

http://www.usfunds.com/landingpages/WhatsDrivingGold-Webcast0309/index.asp

Wishing you all a pleasant weekend,

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal

 

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