Time to Revise Our Gold Expectations

The price of gold is showing signs of stability after gold stocks got crushed in the commodity sell-off early this fall. However, we are clearly not in the $1000-plus gold price environment many had anticipated under these dire economic conditions, nor have traditional multiples returned, says Credit Suisse analyst Anita Soni.

Apart from a brief period earlier this year, when gold hit an all-time high above $1030 an ounce, the yellow metal has not performed true to course. The first quarter advance proved to be a bubble with large-scale institutional speculators driving the price sharply higher... and then sharply lower over the next seven months, according to Jeffrey Nichols, managing director at American Precious Metals Advisors.

Mr. Nichols told the China Gold & Precious Metals Summit in Shanghai on Thursday:

In spite of the lack of direction and day-to-day price volatility in the gold market this year, at least we can say that no other asset class has held its value quite so well.



"Clearly the standard 1 to 2 times price-to-net asset value [NAV] paradigm no longer applies, particularly for the more junior stocks,” Ms. Soni said in a research note, adding that exposure to base metal by-products is no longer a guarantee of lower cash costs. For senior producers, P/NAV multiples are around 0.5 times, while they range for 0.66x for mid-tier names and as much as 1x for small market cap companies.

Until longer-term valuation fundamentals matter again, Ms. Soni believes she has determined an appropriate near-term basis for valuing gold equities. It uses spot commodity prices plus 10% to determine net asset values: $850 per ounce for gold, $10.50 for silver, $1.80 per pound of copper and $0.58 for zinc.

This produces returns between 30% and 60%, which she considers a reasonable near-term basis for valuation until gold moves upward again. Ms. Soni has also produced target prices and net asset values for the long term, with an extra 10% for gold again, or $930, a level she said is “imminently achievable.”

As a result of these changes, Credit Suisse has upgraded its rating on Kinross Gold Corp. (KGC) to “outperform,” while Yamana Gold Inc. (AUY) and Northgate Minerals Corp. (NXG) have been downgraded to “neutral.” Target price reductions for the miners it covers range from 18% to 80%.

“The issues in the mid-tier space are those of operational risk and to a lesser extent, the spectre of potential funding shortfall,” Ms. Soni said. Yamana’s recent production and cost revisions have not be well-received, sending its share price multiple from near-senior levels to the discounted mid-tier level.

She cited several other near-term issues that could weigh on the stock. Its production ramp-up will likely be slower than expected and the market may show a lack of patience with this.

Yamana’s capital program funding could get very tight if current market conditions and commodity prices persist, which may make it very hard for the company to resist issuing equity given the success Agnico-Eagle Mines Ltd. (AEM) and Red Back Mining Inc. (RBIFF.PK) have had with their recent financings.

Cut-backs to preserve capital will hurt its value in terms of adding exploration and growth opportunities, and Yamana currently has significant exposure to copper.

And while Ms. Soni suggested that Yamana is perhaps the best candidate for a takeover given its low valuation and a few very good assets, particularly El Penon in Chile, she says this is not enough to recommend it as an “outperform.”

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