Low in Gold and Gold Stocks

by Barry Dawes

Key Points:

  • Demand for physical gold continues strongly.
  • June End of Financial Year Sale provided great bargains.
  • Gold Index up 32% from low but still down 69% from highs.
  • “V” bottom likely to have been established in June.
  • Seasonal activity likely to give outstanding short term.

Well, the irrational End of the World for the Australian Gold Sector (ASX XGD) ended itself on 27 June 2013 in the End of Financial Year Sale frenzy.

Note this date.  It will probably be like 21 January 1980 when gold peaked at US$887/oz and may be like 23 September 2012 when gold hit US$1923 but certainly like the 24 Oct 2008 XGD low in the GFC at 2674.

The 77% fall in the XGD from 8499 on 11 April 2011 to 1984 on 27 June 2013 was in just over 26 months.  And the A$ gold price extreme low on 27 June 2013 was A$1293* – just 8% lower at this XGD low than the A$1397* at the XGD high.  (* Note volatile intraday movements and can be at variance to these numbers from data services figures.)

It is now at A$1446 and 3% higher than in April 2011. The XGD has risen 32% from the June lows but is still down 69% from those highs.

Of course it was just bad management by the mining companies and they obviously did not deserve the previous rating.  More of that later.

But really, experience in markets strongly suggests the extremes referred to in Dawes Points of 8 July 2013 provide good evidence that a major low is in place and V bottom is likely to eventuate.  Expect some rapid acceleration soon.

In previous Dawes Points reference has been made to this Corrections graphic that had shown the typical bull market corrections of ~25%. After each correction the XGD rallied and went on to make new highs.  Reference was also made to the 63% fall by XGD into the GFC lows in October 2008 and the subsequent rally that took the XGD up 218% to new all time highs again in just 30 months.  Reference, too, was made to that after the completion of this last extraordinary fall (77% lower over 26 months – but who knew when and at what level it was going to stop over that period!!) that the XGD would again make new alltime highs within just a few years.   Nothing has changed to alter this view!

If gold is still in a bull market then it is yet to make its highs.  Commodity markets tend to have considerable volatility and usually end in some spectacular blowoff phase.  Gold has some very special emotional characteristics and the debt issue is still with us and with the immense volumes of liquidity that have been pumped into the global financial system it would be strange to think that it is all over.  So expect a very much higher gold price in the years ahead.  And greatly higher prices for good gold shares!

If XGD did rise to new highs as I expect then the XGD would have risen 325% from the lows.

The rally from the 27 June low has been 32% to date.  The EOFY Sale was a wonderful low entry for those with some cash. Up 32% for XGD, up 100% for SAR, 75% for MML, up 73% for  EVN, 60% for NST, 56% for BDR,  and even 35% for NCM.

Gold itself looks very robust and seems to be beginning that strong short cover rally.

To me, this says the first downtrend has been broken, gold has come back and supported on that first downtrend line, is testing the new downtrend and today has surged upward to US$1345.

Targets are US$1350, US$1400, US$1420, US$1470 and then US$1600. After that it will be new highs.

These chart targets are useful and help piece together the puzzle of whatever the outlook is for resources markets around the world.  It is all connected, we just need to work out how.

Fundamental analysis rarely seems to work nowadays and it seems that there is too much loose capital sloshing around that has provided volatile market actions that defy logic and therefore unsettle investors and cause their withdrawal from markets.

Fundamental analysis of supply and demand (record physical demand, large obvious short positions, record sovereign debt etc, little growth in mine supply, concerns over who actually has the gold etc) and the reasons for buying or selling gold (household hoarding, central bank buying etc) seem to have had little impact over the past couple of years since the Sept 2011 highs so it is necessary to just view the market performance.   And the market performance says Bull Market!

In Japanese Yen terms Gold made new highs in April 2013, almost 18 months after the highs in US$ gold in Sept 2011.  That is a Bull Market in the world’s third largest economy.

Coming back to the issue of strong demand for physical gold, recent data has confirmed earlier indications that China has overtaken India as the largest demand bloc for gold and together their combined absorption has been over 3000tpa in 2013.  Shanghai gold deliveries of 708t in June Half 2013 were 54% higher than in 2012. Mine production is just 2700 tonnes.

It would not be irresponsible to suggest that the physical market for gold is now really tightening up and the shenanigans being played by hedge funds and bullion and investment banks may just be coming to an end.

These graphs of total and registered gold in warehouses at COMEX tell one story.

but  there might  be more to it than that  as this next graphic shows.

COMEX inventories certainly rise and fall with the gold price but it is where the gold is going now that matters.  Falling COMEX inventories at a time of lower gold prices suggests to me that investors are taking delivery here and limiting access to players in the futures markets.

If it is being shipped off to Asia for sale at a US$20/oz premium or minted into coin and bar also at a premium then it is saying that freely available gold is likely to be drying up.  Gold has also had recent periods of backwardation when future month prices are below spot.  As gold is currency, it almost HAS to be in contango to reflect its interest-rate related carrying costs. This means gold supply is very tight.

170,000t of gold is sitting above ground and is of course always available for sale at any time but the character of the gold market is strongly suggesting that apart from the Roladex market manipulation of last April (that appears to have been aimed at spooking late entry holders of the gold ETFs to sell their gold back to the shorts) no one really wants to sell their physical gold anymore.

The matter of fiat currencies with their bonds at grossly inflated values will be coming home to roost over the next decade so expect higher interest rates (although still probably negative real rates) to run for decades from the recent lows.  And it will be the capital flows from bonds that will drive funds into equities and hard assets like property, art and antiques and also into commodities as people strive to keep up purchasing power of accumulated wealth.  This is certainly happening.

The rise in gold and bond yields does not need to be negative for the economy overall but there will certainly be winners and losers.  As pointed out earlier, bond yields (interest rates) rose for 39 years after the last cyclical low in 1942 and it was only 1974/75 and 1982 that experienced major dislocations.

There is much more debt of course but floating currencies since 1971 have a wonderful way of easing some of the imbalances.  Indications of just how currencies will perform over the next decade might become much clearer by end 2013.

In recent presentations I have discussed my fascination in Google and Facebook as major business platforms in the revolutionary new global economy.  Not Social Media for teens and twenty somethings to exchange photos and idle chit-chat but as platforms that will deliver dramatic improvements in productivity and global enterprise especially in marketing of services and products.   Ignore these major platforms at your peril.

Back here in Australia, the 27 June 2013 low took the XGD back to the levels of 2003 and undid a decade of exploration, discovery, resource estimation, reserve proving, establishment of mines and building of plants.  Many A$ billions spent and then discounted and ignored. Who would have thought it possible?

So the June 2013 low is a very important low.

The issue of participation comes back yet again.  If Australia had a more effective capital market with more participants active in the resources stocks then the volatility would not have been so great.  A hundred money managers with a hundred different views would be enough to stabilise the resource market.  Not just a dozen or so playing in the bigger stocks.   The concentration of shareholdings in small and midcaps by directors, executives, workers and suppliers (mostly in WA) was probably the most unfortunate issue.  Cutbacks to non essential capex, exploration, operations and mining and engineering services would have affected many so the rush for liquidity by mining sector participants would have been substantial but was not matched by a largely cashed up market eager to seek the bargains.  At least until after July 1.

The mining industry had certainly experienced a boom as shown by capex, exploration data and wages growth.  The Australian mining industry has had great cost increases as it pushed on with developments and dragged in tens of thousands of new workers.  ABS data shows that over 200,000 people were employed in the mining and oil and gas industries at June 2012.   Average weekly earnings in the Mining Sector were A$2426 as of Nov 2012, 66% high than the average for all workers.

Coming back to Australian gold stocks it could be argued that great expectations had been built into gold stocks prices into 2011 after the GFC sell off and gold’s subsequent strong rise.  A sense of discovery, resource upgrades and new plants was dominant and a renaissance in the role of independent producers was developing beyond the North American giants who now dominate the Australian Gold Production scene after the great asset sell off in the 1990s.  Heady days.  Many new entrants who hadn’t built or run a mine previously or players from big companies that didn’t quite get the small company imperatives of cash and survival meant that many things were not done quite right.  And of course the suppliers to the mining industry had a field day with gouging everywhere.

The past couple of years in a bear market may have provided the wringing out of expectations but in doing so has re-established value.  Reports from the miners express the view that pricing on so much from drilling, mining contracting, geotechnicians and mining wages have been brought back sharply and often by more than 20%.  Many recent graduates have been put off after the mad scrambling of the 2010-2012 rush and more sober expectations have been re established.  But while the demand for inputs to new projects will continue to rise the project managers will be more experienced and will overlay reality on expectations.  We hope.

Rises in operating and capital costs had gone too far but lower grades and rising diesel costs can only mean a higher cost base has  been established and that gold mining globally needs much higher gold prices.  And I think they are coming.  US$2000/oz is now needed for marginal and frontier new mines.  Financiers will probably demand it for major new projects.

Back to the stocks and I am very impressed with the drive for new discoveries in Australia and particularly beyond the immediate Yilgarn Achaean Greenstone Belts in WA centred on Kalgoorlie. This region is by far Australia’s biggest gold producer but its highly fractured and altered rocks aren’t always readily mineable and so it can be a high cost region.  The infrastructure, workforce and mining services bring about ease of operations that makes overall costs lower and very competitive.

Discovery and development have brought Independence Group in its Anglo JV at Tropicana, Regis with its 10moz at Duketon, Gold Road with Central Bore, Breaker Resources has some early results at Dexter some others are looking in the outer reaches of the Yilgarn.

Other important developments in WA provinces are Gascoyne in the Gascoyne, Northern Star in the Ashburton, Mutiny Gold’s Deflector project around Gullewa and a few companies are sniffing around Telfer and the Musgraves and there is ABM Mining in the Tanami.  Signature Gold is looking for Intrusion Related Gold Systems(IRGS), a relatively new exploration target concept,  in Qld.

New South Wales is stealthfully creeping up and efforts returning to the alluvial goldfields of the 1850-70s has come up with some major resources and mines.  Newcrest’s Cadia Valley with 24moz reserves from a resource base of over 130moz produces over 400kozpa rising to as much as 800kozpa for 2017.   The Peak Gold mine at Cobar produces 100kozpa with a resource of 800koz.  Lake Cowal is still looking good for a few more years yet.

Special mention needs to be made of the remarkable Mt Adrah discovery by Sovereign since its acquisition of Gossan Hill Gold.   1000m of continuous mineralisation could indicating something a lot more than the current 3-4 moz targets.  This is another IRGS deposit and I think we will be hearing a lot more about this deposit style.

The performance of the XGD falling 77% from its high would ordinarily expect devastation to have fallen over the sector.  Lower gold prices and mine closures etc etc.

Well what actually did happen?

Of the 38 stocks in the XGD only a few companies had real problems while another handful had to make adjustments.  Focus Minerals being a high cost producer has suspended some operations, Tanami Gold suspended Coyote to reappraise operating procedures, Newcrest had a few minor issues with Gosowong temporary low grades and with Telfer being a difficult and high cost mine, Silverlake had some acquisition teething issues and Alacer was  having problems with its WA high cost mines.  Perseus had mill problems at its Sissingue mine but Edikan was OK.  Kingsgate restructured ops at Challenger.

The lower gold price caused many boards to play it safe and write down values of recent acquisition or the market values of listed stock held at 30 June.  The Newcrest A$5.8bn was most obvious but the net effect for it would be to have no impact on cashflow, tax or debt positions but would reduce amortisation charges and increase net earnings.  Alacer made writedowns on its Australian operations and has put them on the market. Oceanagold and Kingsgate made operations write downs whilst NST, RSG and ALK wrote down carrying values of investment in listed companies.

Many companies have prudently cut costs and deferred capital in the manner described above as reality is allowed back into input pricing.  The issues relating to industry wide acceptance of total all up costs is certainly forcing the reality and the market should expect a more determined industry to do things better.

The bottom line though is, as the table below shows, almost all companies produced in line with expectations, and other than the obvious of reducing revenues and operating cashflows the impact was minimal.   A$ gold prices averaged around A$1600 for about 18 months to end 2012 and probably A$1440 so far in 2013.   The 10% reduction in A$ gold prices should not have had the overall impact of a 77% fall in the XGD.

(click here to open the below table in a separate window)

Most of these companies should therefore recover and many look very good.

The leaders will lead (NCM, RRL, BDR, KCN, NST, PIR, SBM and SLR) and the rest will follow.  Some will do very well.  The smaller stocks will also have their turn and should provide exceptional performances.

The US$ gold price is moving up and the End of Financial Year Sale prices are quickly receding!

Get aboard

13 August 2013

Leave a Reply