Fancy a new toga?

His­tory shows us bul­lion re­tains its buy­ing power. But what about much ne­glected gold shares?

Finweek English Edition - - INSIGHT - DAVID MCKAY davidm@fin­

THE STORY GOES that in the days of Rome’s em­pire an ounce of gold could buy you a rather fetch­ing toga. These days the same weight of gold will buy you a rather nice suit, pos­si­bly of the Ital­ian kind. The moral? Well, those who sub­scribe to such mytholo­gies say it’s about how gold re­tains its buy­ing power while pa­per money – such as the US dol­lar – is los­ing its.

In fact, gold is rapidly in­creas­ing its buy­ing power. At the time of writ­ing, the price of gold was through US$1 600/ oz – an all-time record. The ques­tion for in­vestors is: Does it still make sense to put money di­rectly into the metal through an ex­change-traded fund (ETF) or is South Africa’s much de­rided gold stocks the way to go?

The HSBC says the big names in gold shares – the likes of New­mont Min­ing, Bar­rick Gold and An­gloGold Ashanti – have been dis­count­ing on a much lower gold price: around $1 300/oz against the cur­rent level. “We see po­ten­tial near-term rerat­ing of up to 20%, par­tic­u­larly for the larger cap names, with fur­ther up­side be­yond that,” says Pa­trick Chidley, an an­a­lyst at the bank.

Says RBC Cap­i­tal Mar­kets: “Most se­nior golds are 10% to 20% be­low their 52-week highs – with An­gloGold Ashanti, Gold Fields and Kin­ross Gold hav­ing the great­est up­side to their 52-week highs.” Since that re­port was writ­ten, SA’s gold in­dex has gained al­most 10%, so there’s still time to pile in. Only that…

Will South African gold shares ever per­form as well as the metal, es­pe­cially if you give cre­dence to some ex­pec­ta­tions the gold price will force its way through $2 000/oz, es­pe­cially as dis­tress con­tin­ues apace in Europe? In Jan­uary, JPMor­gan sug­gested 2011 would be the year gold shares out­per­formed the metal. How­ever, the stock­bro­ker was bet­ting on a gold price of $1 463/oz.

What’s hold­ing our gold coun­ters back is what was de­scribed in a re­cent Mer­rill Lynch re­port as “The South African dis­count”. JSE-listed gold shares used to at­tract “the gold pre­mium” – but that’s since been re­placed by a witch’s brew of neg­a­tive fac­tors, from restive labour to the re­newed threat of power short­ages to a long range of other stuff: the threat of na­tion­al­i­sa­tion and class ac­tion suits re­lated to sil­i­co­sis, a disease some claim gold min­ers con­tract.

“Most of those is­sues aren’t new and there­fore largely re­flected in the ‘ South African dis­count’,” says Bruce Al­way, an an­a­lyst at Mer­rill Lynch. “Fur­ther­more, with ris­ing re­sources, na­tion­al­ism a global – not just a do­mes­tic – is­sue, on a rel­a­tive ba­sis the coun­try dis­count shouldn’t dra­mat­i­cally widen, in our view.”

The safest ap­proach to South African gold stocks is to un­der­stand which have the best ex­po­sure. Leon Ester­huizen, a gold an­a­lyst at RBC Cap­i­tal Mar­kets, in a re­cent re­port said 61% of An­gloGold Ashanti’s pro­duc­tion was from out­side SA com­pared with Har­mony Gold, where 92% of its to­tal pro­duc­tion is lo­cal. So the de­ci­sion should be clear – if it’s gold stocks you want.

But here’s the sting in the tail. Over the past year Har­mony Gold has out- per­formed An­gloGold Ashanti and Gold Fields on a rel­a­tive ba­sis. Why? Well, there’s that mam­moth gold de­posit sitting in Pa­pua New Guinea that Har­mony wants to de­velop and which could change the shape of the com­pany, pos­si­bly invit­ing a mouth-wa­ter­ing con­trol pre­mium. As vet­eran gold an­a­lyst Nick Good­win has of­ten com­mented: gold shares are for trad­ing, not hold­ing. If it’s young Johnny’s ed­u­ca­tion you’re in­vest­ing for, the choice might be to go for gold.

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