Positives And Negatives For Gold And Goldminers

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– Gold price may have bottomed
– Miner valuations and ratings slashed
– Balance sheet issues may surface
– Stock preferences considered

By Greg Peel

Last night the US dollar gold price gave way to pent up pressure and breached US$1300/oz to the upside, unleashing a wave of short-covering and break-out buying. With the subsequent near-forty US dollar jump in price to 1335, gold has now bounced 13% from the intraday low of 1180 hit on June 28. That low represented a 26% fall from the April 1 price of 1600.
 

The collapse of the gold price has been mildly less dramatic for Australian gold investors, with the plunge in the Aussie dollar in May helping to stem the losses in Aussie dollar gold. The currency effect has also provided an element of relief for Australia’s shell-shocked gold producers, albeit not enough to change the goldmining landscape significantly.

The sudden plunge in the gold price has been widely put down to a “last straw” capitulation by gold investors who had expected rising global monetary inflation due to increasing global money printing. When Japan’s sudden surge of yen printing failed to move the gold price dial, the writing was on the wall. So when the Fed began hinting that QE might have reached a peak, the floor gave way.

But if you really want to know what triggered the gold price collapse, have a look at this graph:

When Germany asked for its gold back from the US, which has been held on Germany’s behalf at Fort Knox since World War II, the US bullion banks quickly needed to come up with actual, rather than paper, metal. It will take a while for the repatriation to be completed but in the meantime a bit of a nudge from the bullion banks was all that was needed to ensure they could pick up physical gold at lower levels.

The dust has now settled, and JP Morgan is just one broker who believes the US dollar gold price may have seen its low for now. The significant price adjustment will lead to responses from both the supply-side and the demand-side which should ensure a floor.

On the supply-side, the availability of scrap gold will recede, suggests JP Morgan, by around 3.4moz year on year. Goldminers globally will cut their mine output and reduce their forward production expectations and recalibrate the cost bases of physical inventories.

On the demand-side, jewellery demand should surge from traditional buyers (Asia, Middle East) as is always the case when the gold price corrects back to prices more accessible to the middle classes, while an investment response should also be forthcoming after such a steep correction following 21moz of ETF liquidations year to date. JPM suggests a 5moz year on year increase in jewellery demand and a 4moz increase in investment demand.

Earlier this month celebrated US trader and television regular Dennis Gartman decided to cover his US dollar gold shorts based mostly on the sharp reduction in short positions on Comex at what have since been the price lows, but also from a contrarian point of view because of the overwhelming negativity of commentators at the time. He covered his shorts rather than go long, preferring to trade long through goldminer stocks instead. (Gartman Turns Bullish On Gold(miners))

Last night the break-out in the US dollar gold price through the 1300 level has prompted Gartman to re-establish long positions in yen and euro-denominated gold, despite suggesting the US dollar price may yet fall back to the break-out level before pushing higher.

Macquarie is another broker who believes gold has “potentially found a floor”, although the analysts are not forecasting any overwhelming price rebound. Macquarie and JP Morgan have both now adjusted their gold price forecasts and reassessed their Australian goldminer earnings forecasts, price targets and ratings as a result. It’s not a pretty picture, irrespective of a shared belief we may have seen the worst for the time being.

JP Morgan has cut its gold price forecasts over the next 18 months by around 20%. The result is earnings forecasts downgrades for goldminers in excess of 40% on average, which includes a 7% offset for the lower Aussie dollar.

PanAust ((PNA)) and OZ Minerals ((OZL)) are the two miners under JPM’s coverage that are most leveraged to the fall in the Aussie, while Sandfire Resources’ (SFR)) low percentage of gold earnings actually means a net forecast upgrade on the lower currency. The broker has PanAust and OZ on Overweight rating, along with major producer Newcrest Mining ((NCM)) given its lower cost assets. Sandfire’s rating is Underweight.

JP Morgan does not expect goldminer costs to suddenly fall as a result of the fall in gold price, and suspects all-in costs will remain high over FY14. On a gold price under US$1300/oz, Regis Resources ((RRL)) and OceanaGold ((OGC)) are the only two miners under the broker’s coverage which will remain cash positive after all capex is included.

That said, JP Morgan believes Regis is now fully valued while cash costs are creeping higher and as such has downgraded its rating to Neutral. Oceana remains on Overweight. Alacer Gold ((AQG)) has been downgraded to Underweight on valuation. While the broker applauds Alacer’s plan to sell off its Australian assets, it might be a bit tough to find a buyer in the current environment.

Elsewhere, JP Morgan retains a Neutral rating on Evolution Mining ((EVN)) and Perseus Mining ((PRU)).

If JP Morgan has taken a scalpel to its goldminer forecasts and ratings, Macquarie has taken a chainsaw.

The broker notes most Australian producers have responded to the funding issues presented by the gold price fall through a combination of assessing available credit lines, rolling debt maturities, and cancelling or delaying low-return projects. If the gold price fails to rebound significantly, and Macquarie does not think it will, preservation of goldminer balance sheets will be the focus for nervous investors.

Macquarie suggests Alacer, Silverlake Resources ((SLR)) and Chesser Resources ((CHZ)) will require additional debt capacity over the next twelve months. Those companies likely to burn through existing cash balances as they progress with development projects include Alacer, Papillon Resources ((PIR)), Gryphon Minerals ((GRY)) and Ampella Mining ((AMX)). Those companies with safer balance sheets include Newcrest, St Barbara ((SBM)) and Evolution.

Based on low cost operations and free cashflow generation, Macquarie’s preferred goldminers are Regis and Beadell Resources ((BDR)). The broker has retained Outperform ratings on Regis and Beadell along with Papillon, Chesser and Newcrest.

The broker has downgraded the ratings of several other stocks under coverage, with Alacer, Evolution, Silverlake and St Barbara falling to Neutral from Outperform and Ampella, Gryphon, Kingsgate Consolidated ((KCN)) and Perseus falling to Underperform from Neutral. A knife has also been taken to target prices, with cuts averaging 20% on a range from zero to 60%.

Morgan Stanley has undertaken a simple “snapshot” analysis of its gold stocks under coverage by inputting a range of fresh gold price assumptions into valuation models to see what numbers come out the other side. The analysis is “simple” because it assumes no dynamic response from miners, such as asset sales or cost reductions, and assumes a fixed currency.

The analysis favours low-cost operators such as Medusa Mining ((MML)), Morgan Stanley notes, while those with cash balances providing a floor to valuation, such as Alacer, and those with both cash balances and low costs, such as Regis, also prove most resilient.

The broker remains Overweight on Medusa and Equal-weight on Alacer, Evolution, Gryphon, Perseus, Regis and Resolution Mining ((RSG)).
 

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