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Analyst report
Aussie stocks exposed to gold bull run
April 9, 2008
Brendon Lau, ShareAnalysis
After outperforming most of their peers since the start of the year, gold stocks suffered a sharp tumble two weeks ago when spot gold prices crashed by over US$100/ounce. Shareholders in Australia's leading gold producers might be missing the big picture if all they are focusing on is the wildly swinging gold price.
While in US dollar terms gold has been breaking new record highs since late 2007, gold has been stuck in a trading range in Australian dollar terms since 2006. Since Australian gold miners report in earnings in Australian dollars, the surge in gold prices over the last several months may add little to their bottom lines.
Conversely, gold's steep sell-off a fortnight ago is also unlikely to hurt earnings much. So fretting over the US dollar-denominated gold price is hardly a productive use of time.
This "phenomenon" is not hard to understand, as gold has long been regarded as a safe-haven asset during times of economic strife. Since the sub-prime storm rampaged through global markets, one of the key worries has been the waning US dollar. As the outlook for the greenback is still overwhelmingly bearish due to expectations of further US interest-rate cuts, investors have piled into gold on the belief that the value of gold would hold regardless of the US dollar.
There are other fundamental reasons why the gold price has rallied from around US$200/ounce since the turn of the century, but we suspect that the faltering US dollar has been the primary driver ever since global equity markets dived last year from the sub-prime scare. Over the last seven months, the Australian dollar and the euro have shown an unusually high correlation to the spot gold price in US dollars. Thus, as the gold price jumps to a new high, the stronger A$/US$ exchange rate eats away a chunk of this gain, and when the gold price falls, the reverse happens.
So if the gold price benchmark is not a good determiner of value for our gold miners, what is? One key driver is "cost". Rising costs have affected practically every sector, especially industries that are labour and capital intensive. The mining industry has been hamstrung by shortages in manpower and equipment as they struggle with infrastructure bottlenecks and rising mine-development costs. Furthermore, the strong Australian dollar could leave gold producers worse off due to its impact on their margins.
There are also other important factors affecting valuations of our gold miners, such as the amount of gold reserves, the type of mines and exploration. Sadly, the industry has largely underinvested in exploration, as gold had fallen out of favour till a few years ago. Gold producers seem to prefer merging or acquiring rivals as a short-term solution to bolster growth. M&A speculation has been one of the factors supporting our biggest gold producer Newcrest Mining (NCM).
Unfortunately, based on fundamental valuations, investors will find precious few bargains amongst our gold miners, even though we have a positive outlook on gold prices in US dollar terms, as the factors that have supported gold are still very much in play. However, if you are looking to profit from the gold price trend, you would probably be better off investing in alternative products that give you direct exposure to the precious metal instead.
Two stocks we like to highlight that are leveraged to the gold industry are Oxiana (OXR) and Newcrest Mining (NCM).
OXR has proposed a merger with Zinifex (ZFX) to create a A$12B mining house. Shareholders of ZFX will vote via a scheme of arrangement whether to proceed with the deal, while OXR shareholders will have no say. However, OXR is not paying the usual 30% takeover premium to purchase ZFX. This deal is a true merger where both parties benefit. We remain bullish on base metal prices in the medium term, and see OXR's bid as well timed. We have a BUY on OXR with a 12-month price target of $4.40.
NCM is our largest gold miner. Following our review of the three-year forecasts for gold, copper and the A$/US$ exchange rate, NCM's EPS forecasts for FY08-10 have increased by 13.6%, 33.1% and 26.9%, respectively. However, we maintain our view that on a DCF basis NCM is largely overvalued, with the diversified resource companies offering better value. We have a SELL on NCM with a 12-month price target of $31.24.
Brendon Lau is the editor of ShareAnalysis, a premium retail investment service offered by Aegis Equities Research. Click here for your free trial.
More articles from this edition of CompareShares:
Investing: Story of a long-term investor - Kerrie Brown
Investing: Why inflation is bad for your wealth
Stocks: Aussie stocks exposed to gold bull run
Trading: April is a fool's paradise
Expert Panel (warrants): Why are gold and crude oil prices going up?
Opes Prime: Opes administrators find linchpin firm in Virgin Islands
US: Alan Greenspan says US is in recession
Opes Prime: Opes investors dismayed by collapse
Companies: BHP shares surge on Chinese rumours
Sub-prime: Credit market turmoil persists, says IMF
Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions. |
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