THOM CALANDRA'S STOCKWATCH - Gold stocks valued below spot price. Some producers trading as if metal is 10 percent lower
cbs.marketwatch.com By Thom Calandra, CBS.MarketWatch.com Last Update: 12:12 PM ET March 3, 2003
SAN FRANCISCO (CBS.MW) -- Not six months ago, gold miners were the stock market's biggest money-maker. Now they're the new whipping boys.
Investors are treating mining companies as if the price of gold were 10 percent lower than it actually is, says a veteran metals-watcher. This is a rare occurrence in an industry whose share movements the past 18 months have magnified gold's gains by a factor of three or more.
After a brisk gold run to almost $390 an ounce, bullion in recent weeks has lost about 10 percent of its value. On Feb. 17, the metal's spot price touched $341.50 an ounce, its lowest point since the 2002 year-end rally that took it above $340. The metal, which attracts investors during terrorist flare-ups and in economic crises, has lost ground in all major currencies.
Even the weekend capture of a notorious terrorist suspect in Pakistan may send gold, hovering near $350 an ounce, down another 10 percent in coming weeks, say the skeptics. Some short-sellers, primarily $100 million (and less) hedge funds, are actively promoting gold-miner shares as doomed to lose 50 percent of their value in the next six months.
On Monday, gold stocks were selling off sharply in all of the world's major equity markets, down 3 percent and more to their lowest point since mid-December. The spot price of gold in New York also was taking it hard, down almost $4 to $345.80 an ounce. See Financial Times Gold Mines Index.
Against this backdrop, say gold-bashers, the group facing the biggest risk is gold-mining shares, in particular the highest-fliers whose market values tripled and quadrupled in less than two years. That includes small exploration companies such as Canada's Nevsun Resources (CA:NSU: news, chart, profile), which last year was the world's biggest-gaining gold share after its promising discoveries in the west African nation of Mali.
With swollen market caps, mid-sized companies such as Meridian Gold (MDG: news, chart, profile) remain vulnerable even after a 15 percent drop since mid-December, say Wall Street's gold critics.
The largest companies, among them Barrick Gold (ABX: news, chart, profile), are thought to be susceptible to coming losses for a variety of reasons, among them dwindling prospects for new discoveries, complex balance sheets and a looming wave of insider selling.
In the face of that skepticism, veteran gold watchers are steadfast. Analysts who have followed bullion since its heyday of the late 1970s and early 1980s deliver what looks like a unanimous verdict: the gold rally is merely on pause and will resume later this year.
John C. Doody, the dean of quantitative analysis for gold shares, says most gold producers, large and small, are still incredibly cheap against a $350 gold price.
Doody's Gold Stock Analyst is a number-crunching newsletter that sets the standard for the bullion metrics of publicly traded mining companies. In it, Doody regularly evaluates the miners based on their break-even market capitalizations -- the average per-ounce price of their proven and probable reserves plus their cash costs for the gold these companies actually pull from the ground.
When the total comes to less than the current gold price, a cheap gold stock is born.
Doody says the gold producers whose shares are available to investors in North America are selling as if gold were selling for $317 an ounce. Freeport-McMoRan Copper & Gold (FCX: news, chart, profile), based on Doody's market cap-per-ounce premise. Using his measure, Freeport's gold portfolio is valued by the stock market at just $57 an ounce.
"There are many other issues to be considered, such as debt, projects in the pipeline," Doody told me Monday morning from his office in Florida. "Meridian Gold's Esquel, for example, has no proven and probable yet, but the stock is priced as though the market thinks Esquel has 2 million to 3 million ounces."
Mine location is another variable. Is a promising deposit in a country, or a state, where gold mining, is an established business, aided by popular opinion and government regulations, like Canada or parts of the United States? Or is it somewhere that holds great political risk, like Venezuela or Indonesia? "If Freeport's mine were in Nevada, the stock would be $100," says Doody about Freeport McMoRan's Papua, Indonesia, mine, the world's largest gold deposit. Freeport shares sell for $17 each on the New York Stock Exchange.
Among the cheapest gold miners, according to Doody's valuation model, are African miners Randgold (RANGY: news, chart, profile), Ahanti Goldfields (ASL: news, chart, profile), Gold Fields Ltd. (GFI: news, chart, profile) and Harmony Gold (HMY: news, chart, profile). Canada's Eldorado Gold (CA:ELD: news, chart, profile), Peru's Buenaventura Mines (BVNOF: news, chart, profile) and Denver's Golden Star Resources (GSS: news, chart, profile) are also dirt-cheap, Doody says.
Doody says his valuation model is a starting point for identifying undervalued mining shares. "This is a very simplistic approach, but it's a method one can use to start evaluating the gold stocks." The gold analyst is sticking to his 2003 forecast of a $450 gold price.
Others are just as convinced the gold rally is just taking a breather. One of them, Freemarket Gold & Money Report's James Turk, had a February price projection of $430 an ounce for spot gold's price. Turk uses monetary measures, including Federal Reserve-boosted money supply levels, to forecast gold prices, which are influenced by the level of the dollar, pace of inflation and the fiscal soundness of the world's major economies.
Turk, speaking to me Monday from Toronto, says his "fear index," a ratio of America's money supply levels and the country's gold assets, indicates far higher gold prices in the coming 12 months.
"Having missed February by such a large amount, one would think that prudence dictates that I should revise my targets downward, but I haven't," Turk says. "I'm sticking by my fear index, which remains bullish. When the euro starts trading above $1.085, then look for the gold price to start rising again." The euro Monday morning was worth $1.081 in American currency. See: Researcher uses monetary metric to good effect.
Global researchers say the strongest theme for the metal may be a shift by countries, Russia and China among them, to reduce their reliance on dollar-linked paper assets (mainly U.S. Treasury securities) as the main source of their foreign reserves.
"In Russia, the deputy finance minister said dollar reserves should be cut to 50 percent from 70 percent, and gold reserves more than doubled to 10 percent," says Adrian Day, a Maryland fund manager.
First Deputy Finance Minister Alexei Ulyukayev's gold bulletin in Moscow rang bells among commodity researchers, who generally credit central banks with setting long-term trends in the accumulation and disposal of physical assets such as gold.
James T.S. Tu, director of investment management and research at commodities specialist Gerstein & Fisher in New York, says central bankers are becoming convinced their dollar assets will decline under the weight of America's record-high trade deficits and Washington's willingness to triple its deficit spending in the next five years.
"They know the dollar will go down because of unsustainable deficits, unrestrained money supply, a weakening economy and the terrorist/war threat," Tu tells me. "Central banks will be the biggest gold supporters." The increased purchases of bullion will come from countries with large trade surpluses today, such as China (2 percent reserves in gold and a $102 billion trade surplus with the United States in 2002) and Japan (1.7 percent gold reserve). Resource-rich countries that will benefit from a commodity boom, such as Saudi Arabia (7.3 percent gold reserve), also will increase their central-bank gold holdings, Tu says.
Such countries' gold portions of foreign-exchange reserves fall far short of those in developed countries. The United States has about 56 percent of its foreign-exchange reserves in gold, France has 51 percent and Germany has 39 percent. "Central banks design policies that they stick to day after day, year after year. They rarely change direction. Now they're moving away from dollars and into euros and gold," says the Gerstein & Fisher director. "It will last years."
One other positive development for gold could be the introduction of an exchange-traded fund for the metal, says John Hathaway, manager of $215 million Tocqueville Gold Fund (TGLDX: news, chart, profile). Several entities, including the World Gold Council under the direction of Gold Fields' Chairman Chris Thompson, are working with index-asset managers such as State Street Global Advisors to sponsor a gold-backed ETF.
Such a security would amount to the QQQ of gold and trade real-time on a major North American exchange, most likely the American Stock Exchange. The ability to buy physical gold via a stock-market proxy almost surely would boost investors' pen-up demand for the safe-haven metal, market watchers say.
For more on investing, see our March edition of Trading Strategies. Also: Thom Calandra on an explosive short-term war rally.
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