Commodities | Oct 13 2006
By Greg Peel
The gold price has fallen around 20% from its multi-decade highs – from US$720/oz to consolidate at around US$560/oz. This is a support level, and the SB Citigroup analysts suggest a break of this support would see a trade down to US$540/oz.
Nevertheless, the Citi analysts are bullish on gold. They realise their forecasts are aggressive, but they would not be surprised if gold hit US$700/oz again by the end of this year (a prediction firmly stated by GFMS and a conga line of “gold bugs”), and hit new highs (above US$850/oz) in 2007 and 2008.
For the purpose of gold stock valuation, Citi is currently using forward prices of US$675/oz for the fourth calendar quarter of 2006, US$700/oz for 2007 and US$750/oz for 2008. Resources analysts are ever conservative.
The gold price has recently fallen with the oil price, notes Citi, but history shows the correlation between the two varies over time. While recently that correlation has been high as 0.9, historically it is 0.53. In other words Citi suggests gold can break away from its present oil price relationship.
The next focus will be on the US dollar, says Citi, and the greenback is expected to fall due to a weakening in the US economy and the end of Fed tightening. Gold has a negative correlation to the US dollar, but once again that relationship moves in and out of focus over time. Historically it is only -0.50, indicating an each-way bet.
(It was as recently as late last year that gold “de-coupled” from its traditional correlation and rose rapidly despite a rising US dollar fuelled by Fed tightening.)
Further supporting the gold price are the ongoing fundamentals of geo-political tensions, the burgeoning global economic imbalance between the US and most of the rest of the world, and the stated desire by some central banks – Russia, China and Middle Eastern countries among them – to increase their gold reserves.
Physical jewellery demand out of India, China and the Middle East is also a driving factor, although such demand is some 22% down from its peak as the gold price has surged ahead in recent years. Citi suggests current consolidation in the price provides encouragement for renewed buying. While demand has fallen, the slack has been picked up by newfound investor interest in gold and gold instruments.
Miner de-hedging may not be as influential a factor ahead as it proved to be last year and early this year (particularly given the massive unwinding of the Placer Dome book). Many miners who wanted to de-hedge have done so.
Citigroup covers 25 Australian gold miners. Collectively this group has lost 34% in value in 2006 to date against gold’s 20% fall from its highs. The average return this year is 0% compared to gold which is still ahead by 12%. However, the spread of performance is very wide, with the top five performers returning 25% and the bottom five losing 35%.
The top five are Avoca (AVO), Pan Australian (PNA), Lihir (LHG), Intrepid (IAU) and Beaconsfield (BCD), although Beaconsfield is still suspended.
The bottom five are Highlands (HIG), Leviathan (LVR), Ballarat (BGF), Bendigo (BDG) and Agincourt (AGC).
Leviathan’s performance would have been exceedingly worse if it weren’t for the bid from neighbouring Perseverance (PSV) which sparked a 20% rally in the stock. Leviathan sums up the fortunes of the Victorian goldminers who have promised much but delivered little in their attempts to revive the nineteenth century mines of the gold rush. Citi sees ongoing problems for Victorian goldminers.
To exploit a gold price rally through gold stocks Citi advises sticking to the majors. Of all the goldminers in Australia, only two – Newcrest (NCM) and Lihir – boast tier 1 capital. These two enjoy significant reserves to drive growth over the long term and lower costs than all the juniors. Corporate activity in either is never out of the question as well, notes Citi.
In a likely volatile gold market these two are stable forces. They are unlikely to suddenly make huge discoveries through exploration – that is the preserve of the juniors – but they do provide stable returns.
Newcrest is close to overcoming its problems at Telfer, notes Citi, and as such should provide upside potential. The analysts rate the stock a Buy with a target of $26.23 (last close $22.32).
Lihir has run hard but with a good deal of leverage to the gold price the analysts believe there’s further to go. The company is also looking to ramp up its operations. The analysts rate the stock a Buy with a target of $3.61 ($2.98).
The FN Arena database shows 4 Buys and 6 Holds for Newcrest with an average target of $24.51, and 7 Buys and 3 Holds for Lihir with an average target of $3.48.