Australia | Feb 20 2008
By Greg Peel
We all know the gold price has exploded in the last couple of years, fuelled by a declining US dollar, geopolitical tensions, financial market turmoil, and global inflation. Indeed, gold has returned to its once exalted state as the hedge against everything, and particularly as the hedge against paper money. For a long while gold was derided as “the barbarous relic” given the greenback was king and money was as good as free. This meant extraordinary returns were available all over the place, particularly when exploiting carry trades. Gold provides no return. However, extraordinary returns are now looking like a fond memory.
The gold price has rallied 68% in the past two years – from around US$550/oz to over US$925/oz today. It should be a lay-down misere that anyone invested in a gold miner should have also done very well, thank you very much. And the king of them all in Australia is Newcrest ((NCM)). Well, at least the king of the locally-owned brigade. And so it is that Newcrest has ridden the gold wave.
On a strict two-year basis, Newcrest’s share price has improved 40%. If you bought at the low and sold at the high within this period, you would have made 95%. Split the difference and you’d have to say Newcrest’s performance has been at least as good as the US dollar gold price implies.
This is perhaps somewhat surprising, if you discount a certain amount of “gold fever”. For Newcrest has been beset with all sorts of problems along that road. For starters, the Australian dollar gold price has only risen 34% in the last two years. Throughout gold’s spectacular return to favour the Aussie dollar has also appreciated, providing a “head wind” for Newcrest’s earnings.
Then there’s been production problems, the most obvious of which has been Newcrest’s basket-case Telfer. This project once had the prospect of being the biggest gold mine in Australia, but it has done nothing but suffer production downgrades ever since.
And, there’s been a small matter of Newcrest’s hedge book – a legacy of the days when the gold price was going nowhere fast. Newcrest’s share price got a good kick along the day it was declared the hedge book would be closed, for it had encumbered profits in the meantime, given the need to honour contract deliveries at lower prices.
Finally, one mustn’t forget that Newcrest is not a gold pure-play. The company also produces copper. The copper price has risen 55% in two years, but it’s had its ups and downs.
Yet Newcrest has managed to perform about as well as the US dollar gold price in the past two years. Without even doing the same sort of number crunching resource analysts are good at, one would have to conclude Newcrest has run ahead of the game. In fact, this is exactly what seven out of ten brokers in the FNArena database believe.
Operationally, Newcrest’s first half result was a corker. But then you’d want to think it would be, given the acceleration in the gold price and copper prices over that time and the fact the miner is much more leveraged to both since the reduction in its hedge book. But the problem is that closing a hedge book is not the same as closing a Florida subprime mortgage – you can’t just walk away. Realistically you must pay up the difference in gold/copper price for contracts yet to be settled, which means a big hit to immediate profits. Then you have to hope the gold/copper price rises faster in the period than the cost of the hedges had implied.
Newcrest’s hedge book hit was more than many brokers expected. And it’s not over yet – there are still some more contracts to close out.
But analysts are very keen on Newcrest on the basis of the potential growth of its operation (in gold – copper never rates much of a mention) and on the basis they are all bullish the gold price (ditto). If anything, analysts are still a bit behind the price curve, as usual. Newcrest is a stock everyone agrees should be cap-weighted in a portfolio (ie Hold), but only three brokers suggest Newcrest should be overweighted (ie Buy at this level).
They are Merrill Lynch, UBS and GSJB Were, all of whom are looking forward to production increases (and all of whom were once caught out by Telfer). Weres admits Newcrest no longer looks inexpensive compared to global peers, but is still keen. For the rest of the group there are definite positives, including the company’s desire to seek takeover targets. Very low gearing and that reduced hedge fund book are also big pluses.
But on valuation? Seven brokers just can’t get excited at this level.