Weak­ness

Finweek English Edition - - COMPANIES & INVESTMENTS - David Mckay

The gold price is thought to have l i mited down­side si nce it s $220/ounce drop in mid-April, a view partly bol­stered by the like­li­hood that the US will con­tinue to as­sist its econ­omy by buy­ing bonds, known as quan­ti­ta­tive eas­ing.

There’s also the reg­u­lar oc­cur­rence of sur­prise US eco­nomic data that re­minds us the world’s largest econ­omy is still not out of the woods. The con­trac­tion in the US man­u­fac­tur­ing sec­tor ear­lier this week is an ex­am­ple.

So if $1 400/oz seems a rea­son­able gold price go­ing for­ward, then at the cur­rent rand/dol­lar ex­change rate South African gold com­pa­nies can ex­pect a gold price re­ceived of R436 352/ kg. That’s only 6% less than the gold price re­ceived by Gold Fields in the De­cem­ber quar­ter be­fore the gold price was heav­ily as­saulted, some would say.

That’s t he pow­er­ful ef­fect of t he rand’s weak­ness. It would be folly for gold com­pa­nies to plan on the highly liq­uid cur­rency mar­kets, but it sure does take the sting out of the last few months.

For in­stance, the weak­ness in the rand – by some 16% in the last 12 months – has helped pay for the 8% in­crease in elec­tric­ity tar­iffs SA gold com­pa­nies are ex­pected to shoul­der this year (ex­clud­ing the win­ter tar­iff, only tem­po­rar­ily in place for sev­eral months, but which is also 8%).

Quite whether in­creased labour costs, which com­prise more than 50% of gold min­ing cash costs, will be cov­ered by rand weak­ness is the big un­known in charting the fu­ture in­vestibil­ity of gold shares. It’s un­likely on the ev­i­dence of the National Union of Minework­ers’ (NUM) ini­tial de­mands, which ask for as much as 60% for en­try-level work­ers, which trans­lates into a blended across­the-board in­crease in the high teens.

Even with­out as­sis­tance f rom t he r and, t here’s a grow­ing view t hat gold com­pa­nies may come back into vogue; se­lected stocks of cer­tain qual­ity, at least. The re­lief will be wel­comed. The SA gold i ndex shed 27% since the be­gin­ning of the year, and 8.4% in the last month-and-a-half when the gold ex­po­sure specif ica l l y t hrough ex­change-traded prod­ucts was liq­ui­dated.

Since the onset of rand weak­ness, how­ever, the gold in­dex has gained 12% with Har­mony Gold, among oth­ers benef it­ing. Ac­cord­ing to SP An­gel, a UK stock­bro­ker, the shift from ETFs to eq­ui­ties iron­i­cally as­sists gold com­pa­nies, es­pe­cially those of­fer­ing high yields among other qual­i­ties.

The view is sup­ported by Mac­quarie Re­search in a note dated 28 May: “In a rel­a­tively be­nign gold price en­vi­ron­ment (f rom here), and given t he un­der­per­for­mance of the eq­ui­ties rel­a­tive to the me­tal glob­ally, we be­lieve that there are four key rea­sons why gold eq­ui­ties (in this case SA ma­jors) of­fer more up­side than ETFs: div­i­dends, growth, val­u­a­tion and lever­age,” it said.

Ac­cord­ing to the stock­bro­ker, the best SA gold stock of­fer­ing for div­i­dend yield is Sibanye Gold whereas An­gloGold Ashanti pro­vides a growth and val­u­a­tion in­vest­ment case partly given the un­der­per­for­mance of its share price, and based on the fact the com­pany in­tends adding 500 000oz in pro­duc­tion, and pos­si­bly cut­ting the same amount of less prof­itable ounces.

An­gloGold Ashanti is also con­sid­ered one of the most de­fen­sive gold stocks of the SA suite given it has the low­est ex­po­sure to SA. Gold Fields, mean­while, presents a growth and div­i­dend play op­tion

al­though its suc­cess turns on mak­ing South Deep per­form, while Har­mony Gold is the lever­aged play given its near com­plete ex­po­sure to SA, Mac­quarie Re­search said.

Rand weak­ness, how­ever, brings with it prob­lems. Im­ported con­sum­ables such as ex­plo­sives or steel, petrol and diesel (to a limited amount) will all face heavy cost in­creases in about six months’ time. A down­grade by any of the rat­ings agen­cies also make it more ex­pen­sive for SA gold com­pa­nies to raise cap­i­tal. They aren’t alone, how­ever. The World Gold Coun­cil is con­sid­er­ing in­tro­duc­ing a new cost met­ric for the world’s gold min­ers called All-In-Sus­tain­ing Costs (AISC), which when ex­tended by BMO Cap­i­tal Mar­kets to in­clude tax and green­fields cap­i­tal spend, sees only 5% of the world’s gold min­ers pro­duc­ing gold at costs that fall be­low the spot gold price (75% fall be­low the spot price of gold in the World Gold Coun­cil’s met­ric, how­ever).

Both the World Gold Coun­cil and BMO Cap­i­tal Mar­kets don’t be­lieve all gold com­pa­nies ref lect their costs ac­cu­rately and that more f is­cal dis­ci­pline is re­quired. Al­though BMO doesn’t iden­tify any SA gold shares that would benef it f rom such dis­ci­pline, it ’s worth re­mark­ing that An­gloGold Ashanti is 33% be­low its level a year ago whilst Har­mony Gold is no less t han 55% weaker.

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