The prices of gold stocks vis-a-vis the gold price itself seem to be drifting further and further apart. Is this telling us something about the stocks themselves or that the gold price is in excess of where the markets think it should be?
If one examines the fundamentals behind the gold price rise to its current levels - even if this is well below the peak of only a few weeks ago, the logical observer might find it strange that it is not far higher - and there are few specialist gold analysts out there who now believe that the yellow metal will fall significantly below current levels. Indeed a recent survey of mainstream analysts' projections shows that this usually highly conservative group - you only have to look at the London Bullion Market Association's annual gold price prediction competition to see how conservative the top analysts have tended to be in their forecasts - are almost unanimously looking for higher gold prices in the weeks and months ahead. The gold bulls - and even some of these have proved to undercall the gold price rise in the past - are looking for even higher levels and their views should not be ruled out however crazy they may seem to the impartial observer. Remember that only around four years ago a $1,000 gold price looked excessively optimistic when the mainstream analysts were perhaps predicting a long term price of only $500-600, with $700 gold forecasts considered by many as over-the-top!
Coming back to the mainstream analysts - as noted by Ross Norman in an article published on Mineweb yesterday and worth repeating again (see Analysts mostly unfazed by gold price volatility and raising 2012 forecasts) - "The Bloomberg median analyst forecast for the gold price in 2012 rises by about 27% from $1,406 as of 30 June to $1781 as of 5 October. Natixis, the more conservative among the lot, raised its 2012 gold price forecast this Monday by 11.5% to $1,450, followed by Credit Suisse who raised its price forecast by 19% to $1,850 on Tuesday. Goldman reiterated its 12-month forecast at $1860, seeing no changes in fundamentals. BofA Merrill Lynch and Barclays' analysts continued to maintain their 12-month forecast of a gold price of $2,000. Barclays viewed the gold price correction as a temporary move and a buying opportunity. Morgan Stanley this week hiked its 2012 forecast by an eye-catching 35% to $2,200."
Bank analysts by definition tend to err, often heavily, on the side of caution - they hate to be caught out being too positive. But the problem with this for the gold mining stocks is that valuations by the major financial institutions tend to be based on these bank analyses and then discounted some more. So looking at the Bloomberg median figures in June of $1400 suggests that the stocks at that time were probably being valued on a gold price of perhaps $1200 or less - hugely below what is actually being achieved. The miners themselves also tend to run their public projections on even lower-still prices to remain within stock exchange guidelines and so they are not accused of over-egging their profits forecasts - but given they also manage to mostly underestimate costs that is not always a bad thing. However the net result is that those who are actually mining gold will be making profits hugely in excess of any sensible forecast based on analysts' gold price predictions.
The September quarter, for example, will have seen operating gold miners selling their product at an average price of well in excess of $1600 an ounce - probably even as high as an average of $1700 or more given that nearly all are fully unhedged. This is probably around $200-$300 AN OUNCE more than in the June quarter which itself saw record revenues and profits. For a top miner like Barrick, producing nearly 2 million ounces a quarter this translates to a revenue increase of perhaps half a billion dollars! Yet Barrick's stock price is way below where it was in the first half of the year. This does not seem to make any logical sense.
Similarly Newmont - with a quarterly production of around 1.2 million ounces of gold - will likely see a revenue increase of some $300 million. These are staggering figures, yet, although Newmont's stock price has performed better than Barrick's over the past few months - not least because of its perhaps more generous dividend policy which it is now tying to the gold price - it is still below where it was a year ago.
Of the other top North American gold miners, Goldcorp's share price has been similarly lethargic and of the South African majors, AngloGold's share price performance over the past 6 months has been pretty dire, while Gold Fields may have done a little better, but neither have performed anywhere near that which their likely revenue and profit increases through higher gold prices and changing geographical focus would suggest.
There has been a pick up in the various gold indices over the past few days as the gold price is seen as stabilising after its recent fall, but one suspects that when the magnitude of the likely 3rd quarter earnings increases become known there could well be some rerating upwards due - perhaps even a substantial boost.
But perhaps the biggest problem for the majors is the level of ongoing capital expenditure necessary to advance, or even maintain, their output levels as existing mines become depleted, grades fall and new bulk mining low grade projects increasingly tend to be found in more hostile geographical environments leading to huge mine development costs of many billions of dollars.
Increasingly, investors see capital expenditure as a direct cost (and indeed many mining companies are now publishing figures which present it in that manner). While this is indeed a limiting factor, the high gold prices at least are leading to all the majors reporting positive net cash flows after taking capex into account which wasn't necessarily the case even a couple of years ago. They are also beginning to change their focus a little for which they may well be taken to task by the 'pure gold' lobby, but there is a logic in adding substantial by- or co- product output as gold resources are seen as becoming increasingly scarce and expensive to develop. There may also be a trend, perhaps in its early stages, for the majors to seek out smaller high grade operations with a reasonable life - perhaps of a type which they may have considered too small in the past.
To gain a rerating the big gold miners are having to change and, as noted above, perhaps they are already doing so. Virtually all are improving their dividend policies - as with Newmont with its promise of gold price related payouts - but none are yielding more than a little under 2% even at their current low prices and most are below 1%. There is pressure on them from the financial community to improve this record and there are also indications that shareholder pressure due to the poor stock price performance is forcing their executives to be far more proactive and aggressive in setting out their benefits (see Major gold stock promotion now seems to be a competitive sport).
Whether all these factors in combination will have an effect remains to be seen. But there does seem to be a recognition that most gold stocks have underperformed in relation to the gold price over the past several months and that at some stage the market will recognise this. There's also a lot of rubbish talked about the volatility of the gold price which may have been unnerving investors. Because the gold price is viewed in absolutes rather than as an index its movements are perhaps more apparent to the average person yet the major stock indices have actually been just as volatile as the gold price - some indeed more so - over the past few weeks. Headlines like 'Gold no longer a safe haven' have abounded but even the mainstream analysts, as noted above, see gold's downward move as a blip in the ongoing bull market - and an unsurprising one perhaps given the rapid price increase seen in late summer.
