Gold Stocks Offering Value

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This story features NEWCREST MINING LIMITED, and other companies.
For more info SHARE ANALYSIS: NCM

By Greg Peel

Since Christmas, the gold price has been stuck in a range from about US$1060/oz to US$1140/oz with plenty of frustrating movement in between. Just when gold looks like making a break one way or the other, it turns heel once more.

The problem is that gold is wearing, as always, two hats at present – one of a commodity denominated in US dollars and the other as an alternative reserve currency to US dollars, or simply an alternative to any fiat currency. At present, those hats are clashing.

The uncertainty since January of potential Greek debt default has sent investors scurrying into both gold and US dollars as a safe haven. The former pushes the gold price up and the latter down. Some days gold seems to shake off its converse mathematical US dollar relationship, and then other days it doesn't. And investors are even more frustrated Downunder, when one throws in volatility-killing, offset currency movements. Gold in Aussie has managed to trade in a range of only A$1200 to A$1260/oz since Christmas.

Canadian gold analysts WJB Capital warned its clients in December that gold appeared overbought over US$1200/oz, having moved 25% beyond its 200-day moving average price. But you didn't have to read tea leaves to know that in gold's recent history, such sudden and dramatic price spikes are usually followed by equally sudden crunches. Then we consolidate and start again.

Consolidate is exactly what gold's been doing lately, but WJB is relieved that consolidation is occurring above the 200-day average and that the line has not been breached. This implies technically that even if gold continues to consolidate for a while, it is still in an uptrend and now not overbought at all.

I noted in my Overnight Report this morning that gold has in recent years spent a good deal of time around US$700 and then a good deal of time around $900. It would be arithmetically elegant if the next number in the sequence were US$1100.

WJB has also advised its clients that what applies to physical gold also applies to Philadelphia listed gold mining stocks such that they, too, are still in an uptrend. But Morgan Stanley would suggest that Philadelphia is not necessarily the place to look for value in listed gold stocks.

Australia is.

Well, the Asia-Pacific region specifically, as defined by the FTSE Gold Mines Index. Newcrest Mining ((NCM)) and Lihir Gold ((LGL)) are the sole Australian-owned gold miners which make the cut in this large-cap index, but Morgan Stanley sees opportunity in Australian juniors as well.

Last week Morgan Stanley Asia-Pacific held its inaugural gold forum, and organisers would have been pleased mining executive presenters were all bullish the gold price.

As well they might be, given major mining houses have spent the last few years clearing their books of hedge positions and thus exposing themselves to the downside. But US dollar gold is up 175% in five years so it's been a fair bet. The plan now is to maximise cash margins by reducing unit cash costs.

To do this miners must grow their resource bases which means either acquisition or exploration or both. There have been no new gold finds of any major significance across the globe in decades, which is one reason focus has swung to the relatively under-explored Asia-Pacific region. Since 2000, the Asia-Pacific component of the FTSE Gold Index has outperformed the gold price and well outperformed the general Index.

The reason for underperformance in the general Index, notes Morgan Stanley, is not only fewer gold discoveries, which make gold stocks less exciting on a “free option” basis, but also the success of gold exchange traded funds which has sucked investment into physical gold and away from traditional investment in the miners.

Ironically, the first ever EFT in the world was the Australian GOLD listing, but its impact has not been near as great as similar US listings.

Morgan Stanley expects Asia-Pacific to continue to outperform the broader Index given the region boasts higher volume growth and lower cash costs. The stockbroker rates Newcrest Overweight and Lihir Equal-Weight (or Buy and Hold respectively if you prefer). But increasing cost pressures across the globe mean the acquisition of the right junior miners is a valid option for production expansion, and premiums can be paid.

So the trick to investment in local junior gold miners (which includes those with greenfield or brownfield projects outside Australia) is to find those with growth potential on a low cost base.

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