Australia | Nov 27 2006
By Chris Shaw
Trader Dennis Gartman went longer of gold last week and Barclays Capital likes the metal from a technical standpoint, so it is no surprise interest in leading Australian gold stocks remains high.
As evidence of this Morgan Stanley recently initiated coverage on the sector in Australia, the broker taking a positive outlook with the view the gold price will remains above its long-term average forecast of US$500 per ounce until at least 2010.
Attractions of the metal in the broker’s view are that it offers portfolio diversification and a safe haven element, while at the same time the metal (similar to the base metals) is enjoying growing demand from emerging markets, India and China in particular.
Other reasons the broker expects the price of the metal to remain strong include ongoing political uncertainty, especially in the Middle East, an increase in the flow of investor funds into gold and the potential for the US dollar to weaken, with is traditionally a bullish factor for the gold price.
From a mine supply point of view there are reasons to be bullish as well, the broker noting the increased costs of mine production are putting off some expansion plans, while producer de-hedging is also proving positive in that it is taking gold out of the system.
At the same time this supply is not being offset by Central Banks around the world, as despite having an agreement in place in terms of how much gold can be sold in any five year period the banks are actually falling short of the total allowable sales, meaning there is less gold supply than otherwise anticipated.
In terms of supply the broker is forecasting global production of 2,856 tonnes in 2010 compared to 2,485 tonnes in 2005, but suggests the risk here is to the downside given grades are falling at operations around the world and the increasing depth of mining in South Africa is driving up operating costs to the point some mines are now not economic.
Looking at specific stocks in the Australian market, the broker has initiated coverage on both Newcrest (NCM) and Oxiana (OXR) with Overweight ratings, but has tagged Lihir (LHG) as Underweight.
For Newcrest the broker is positive towards the new management team, expecting them to improve the company’s operations going forward. At the same time Morgan Stanley analysts see the potential for production at Telfer, the company’s currently troubled flagship operation, to increase by as much as 50% in coming years.
The broker expects such an increase in volumes to result in lower costs, while it sees a good spread of risk in that the company is currently producing from a number of different mines. With a strong correlation to the gold price the broker sees earnings increasing by around 69% from 2007 to 2008.
Similarly Oxiana is favoured as there is production upside at both its gold and copper operations, the company also offering good exploration upside from surrounding areas. Another factor in favour of the company is the strong cash flows it is generating, the broker forecasting there could be more than $1bn in cash on its balance sheet by 2010. With the company also offering good leverage to metal prices the broker feels justified in its positive rating.
Lihir is a different story, the broker is strongly against its recent attempts to expand into the Victorian goldfields as in its view the acquisitions are value destructive and shareholders are being diluted.
Having said that, the broker doesn’t find the single mine operation as attractive given the lack of diversification, particularly as the project is currently experiencing margin pressure from higher operating costs.
One gold stock that has performed strongly of late is Sino Gold (SGX), its recent share price strength prompting Austock Securities to downgrade its rating to Hold from Buy. The change reflects the fact the stock is trading at a significant premium to valuation currently, the broker’s valuation standing at $2.53 at a gold price of US$450/oz and $3.85 at the current gold price.
Despite this the broker likes the longer-term story as the company is about to commence production at Jinfeng in coming months, with production targeted at 145,000 ounces in 2007 and 235,000 ounces in 2008 at cash costs of between US$220-240 per ounce.
As Austock notes the company’s White Mountain prospect is also shaping up as a likely second operations, while the recent joint venture with Gold Fields of South Africa is a positive as it offers additional exploration upside.
As a result the broker suggests investors look to accumulate the stock on any price weakness.
Comparing the Morgan Stanley and Austock ratings to those in the FNArena database shows Newcrest is rated as Buy three times and Hold seven times, with an average price target of $25.97. In contrast, Morgan Stanley’s target price is $29.25.
For Oxiana the database shows two Buy ratings, Seven Holds and one Sell with an average target price of $3.33, again below Morgan Stanley’s target of $3.70. Lihir is rated as Buy and Hold four times each against one Reduce and one Sell rating, with an average target of $3.29 well above Morgan Stanley’s $2.59.
Sino Gold scores one Buy and three Hold ratings, its average target of $5.88 above Austock’s target of $5.50.
Shares of the gold stocks today are stronger, with Newcrest up 70c at $25.07, Oxiana up 10c at $3.32, Lihir up 12c at $3.02 and Sino Gold 16c higher at $5.73 as at 2.15pm.