Time To Be Selective In Gold Stocks

Array
(
    [0] => Array
        (
            [0] => ((NCM))
            [1] => ((MML))
            [2] => ((AQG))
            [3] => ((EVN))
            [4] => ((BDR))
            [5] => ((PRU))
        )

    [1] => Array
        (
            [0] => NCM
            [1] => MML
            [2] => AQG
            [3] => EVN
            [4] => BDR
            [5] => PRU
        )

)

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

-More pain for gold stocks
-Bearishness prevailing
-Time to be very selective
-Strong operations stand out
 

By Eva Brocklehurst

Australian gold stocks have been pummelled over recent months and now gold itself has received a caning. Equities remain further under water than the gold price suggests, despite the latest substantial fall. Is there more correcting to come for the gold price? If so, what is the outlook for gold equities? More weakness?

Citi notes that, despite a raft of catalysts such as the Cyprus bail-out, problems in Portugal, Japanese asset buying and a dysfunctional Italian government, gold has failed to break out of a 2-year trading range of US$1,550-1,800/oz. It must be time for a pull back. Inflation concerns that previously bolstered the gold price are being pushed aside. Moreover, low interest rates and growing liquidity tends to favour other asset classes such as equities. Hence, the gold price is likely to recede to around US$1,435/oz in 2014 in Citi's opinion and the long term price is viewed at around US$1,050/oz. Goldman Sachs has revised gold price forecasts to reflect the start of what the analysts expect is a uniform decline to a long-term estimate of US$1,200/oz in 2018.

JP Morgan notes the fall in gold equities over the past few sessions has in many cases far exceeded the sell-off in gold. This suggests there could be significant changes to mine plans, given the potential value destruction in subsidising marginal ventures. JP Morgan expects near-term sentiment on the gold price will be bearish, amid concerns about further liquidation of gold positions and triggering of stop-loss orders. Goldman Sachs analysts believe the increase in cash costs has magnified the impact of the lower gold price as the margins the companies enjoyed get compacted. This has affected profits much more than a top line drop in revenue. Exploration spending historically follows the gold price, as investors are willing to fund more speculative endeavours when prices are high. As a result, Goldman believes the current bearishness will limit junior miners' ability to raise money.

What does this herald for specific local gold equities? Goldman analysts believe OceanaGold ((OCG)) and Regis Resources ((RRL)) were the best performers over the last year and OceanaGold stands out, following the successful commissioning of Didipio in the Philippines. The worst performer is Canada's dual-listed Teranga Gold ((TGZ)), a high cost single operation that is significantly leveraged to the gold price. Goldman has assessed the Australian gold sector in terms of the value of gold factored into share prices and finds St Barbara ((SBM)) has the lowest gold price factored in. This is explained by the recent acquisition of Allied Gold, which resulted in a sharp drop in the price of St Barbara shares. Goldman believes the sell-off in this stock has been overdone and suggests St Barbara is undervalued.

As for market leader Newcrest ((NCM)), this stock is trading on the second lowest gold price from within the broker's coverage. Why? The operational problems the company has faced recently has caused the market to remove the large cap premium from the stock. The low gold price is also exaggerated by Newcrest's relatively long mine life, which means the valuation is influenced over a much longer period of time. The most fully valued stocks for Goldman are Regis Resources ((RRL)) and Medusa Mining ((MML)), which have US$1,900/oz and US$1,800/oz respectively factored into the share prices. Here, Goldman thinks Regis deserves a premium because of a strong operational track record while Medusa is affected by a relatively short mine life. In summary, Goldman's greatest concern is those stocks with single mines and higher cost operations, as any further decline in the gold price exacerbates the margin squeeze.

For JP Morgan one thing is clear. Now is the time for long positions that are leveraged to a near-term production turnaround and/or production growth. It's a "stockpicker" market in the broker's view and the preference is Newcrest and OceanaGold. Production curtailments are a possibility and this could come from stocks which appear to have good margins. The reason is average metrics can disguise high-cost mines in portfolios, in JP Morgan's view. The broker highlights Alacer Gold's ((AQG)) Western Australian assets, Evolution Mining's ((EVN)) Edna May, Newcrest's Hidden Valley and OceanaGold's Reefton mine as examples.

Moreover, cash costs are losing relevance as investors focus increasingly on free cash flow generation, given the high costs associated with pre-stripping and cut-backs in the case of open pits, and stope and decline development in the case of underground. Focusing on Net Present Value (NPV) will only favour those with low cost and relatively long mine lives and conservative reserve price assumptions, given they can withstand short-term fluctuations, in JP Morgan's view. The broker's least preferred stocks include Evolution Mining, as all-in costs of around US$1450/oz require debt draw-down and there is exposure to commissioning risk with Mt Carlton. Another is Alacer Gold, as positive returns on Copler are subsidising significant loss making at the Australian assets.

Citi notes free cash flow forecasts for the sector in 2014 have fallen by US$900m or 25% in six months. The broker is looking for this as a catalyst for the next phase of production growth and as potential for reducing the negative momentum in the sector. Equities have shown substantial divergence in returns and, for Citi, this underscores the importance of targeting exposure to strong operational stories. The broker's target is stocks that offer volume growth, free cash flow generation and valuation upside. The preferences therefore include OceanaGold, Beadell Resources ((BDR)) and Perseus Mining ((PRU)). The broker notes St Barbara and Medusa may be trading at steep discounts but there are elevated risks near term. Citi finds Regis Resources and Newcrest fully priced, without the operational safety to justify the premium valuations.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms