Wednesday 7 September 2011

Analysis: Gold stocks to outsparkle gold in post-QE2 world


(Reuters) - Gold's performance has eclipsed that of gold mining stocks this year, but gold equities now are likely to take the upper hand as the flow of cheap U.S. cash slows and miners boast juicy margins and good growth prospects.

Gold's status as a quasi-currency and safe haven has helped pushed the price of the metal up about 20 percent since the start of the year to above $1,520 an ounce, making it one of the top performing asset classes of 2011.

That compares with an 8 percent drop in the ARCA Gold Bugs index, which includes shares in some of the world's largest gold miners.

The U.S. Federal Reserve's $600 billion bond-buying program, which has kept down interest rates and the dollar; the disaster in Japan and the violence in the Middle East, which have shaken investor confidence; and evidence of sluggish U.S. growth and concerns about China have all boosted gold but dented global stocks. And gold shares have not been immune.

Now that the Fed's easing program has come to an end, Japan is recovering and China has managed to stave off some of the biggest fears about price pressures, there is some doubt that gold can keep up that strong performance.

Gold stocks, meanwhile, are supported by a gold price near record highs and may benefit from improving sentiment for equities markets. They also appear relatively cheap at the price.

Catherine Raw, who helps manage BlackRock's $4.7 billion Gold & General Fund, said the rise in the gold price has outpaced cost inflation in the industry, meaning that gold miners are likely to see their margins and their profits increase this year.

"I, as an investor, would say that in the end, given that believe the world isn't going to collapse, while there maybe a good few months of volatility left, if you're prepared to be patient, then I would see now as a very good buying opportunity," she said.

"The fundamentals of gold companies have improved, and yet their shares have fallen, and you've seen valuations now much more comparable to the rest of the mining sector. So you're not having to pay a ridiculous premium as you would have done say five or six years ago, and yet margins are growing significantly, in a way that they weren't five or six years ago," Raw added.

VALUE SHINES

Shares in Barrick Gold, the world's largest gold miner, trade at nearly 14 times anticipated earnings, while second-largest Newmont and third-largest AngloGold Ashanti trade at roughly 12 times expected earnings.

This compares with base metal producer BHP Billiton, which trades at nearly 17 times expected earnings, or Anglo American, which trades at 40 times earnings.

HSBC Global Asset Management, which recently unloaded most of its holdings of physical gold in favor of gold shares, said gold equities are two-thirds shares and one-third gold price.

An environment of uncertainty, negative real interest rates and turbulent stock markets will cause gold equities to underperform, even while they benefit from a rise in the gold price, HSBC said.

Historically, gold has outperformed gold mining shares in times of financial market stress and instability. The ARCA Gold Bugs fell by 29 percent in 2008, the low-point of the global financial crisis, while the gold price rose by 6.05 pct.

The index fell 44 percent in 2000, when the dot.com bubble burst, while spot gold fell by just 6.3 pct in that time.

But over the past 10 years while gold has been consistently rising, for a gain of over 400 percent, the Gold Bugs index has risen by 770 percent.

Daniel Sacks, who co-manages Investec's $750 million Global Gold Fund, said gold miners are generally looking much healthier than they did in 2008, because many have issued equity to cancel out debt.

He added that gold miners, as a rule, tend to avoid taking on debt as their lenders encourage them to hedge their future production as some form of guarantee.

"They still don't compare to high-yielding industrial or financial stocks, but compared to their history, gold shares are yielding a lot more than they used to. It's just an indication of the width of their margins," Sacks said.

Sacks said gold equities tend to outperform in the northern hemisphere summer months, largely because of the lull in consumer buying of physical gold. This was not the case last year when the eruption of the euro zone debt crisis prompted an investor push into gold and out of equities.

In summer 2009, however, gold rose 7.7 percent compared with a 31 pct rise in the Gold Bugs index. In 2007, as the extent of the credit crunch was becoming apparent, gold rose 12.6 pct between June and September, while gold stocks gained 18 percent.

"After a rip-roaring 2010 as the metal went mainstream, gold has become the gift that has stopped giving for some investors," said JPMorgan Chase in a recent note. "We feel gold still has a very significant role in portfolios. However, it has become apparent that the metal and the equities act differently."

The U.S. bank added, "Gold equities will remain under pressure while investors remain fearful. Once investors feel that the risk of another leg down in general markets passes, or after a downswing in the markets, we feel the gold equities will do some catching up."

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