30/03/2011 - 08:44

Analysis: value gaps in gold market

30/03/2011 - 08:44

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Tipping the gold price, and the future price of gold stocks, is a mug's game, unless a clear value gap can be demonstrated - which is what appears to have been done in a rather interesting piece of recent research.

Tipping the gold price, and the future price of gold stocks, is a mug's game, unless a clear value gap can be demonstrated - which is what appears to have been done in a rather interesting piece of recent research.

Goldman Sachs, an investment bank with a record for being right more often than wrong, reckons value can be seen emerging in the gold sector because the share prices of some of the best-known names in gold have failed to keep pace with the gold price.

Kingsgate Consolidated, for example, was trading two weeks ago (when the research was compiled) at around $8.18, a price which correlates to a gold price of $US1000 an ounce. St Barbara was trading at $2.23, a price which correlates to a gold price of $US950/oz.

No prize for knowing that the gold price today is around $US1417/oz, and was recently as high as $US1447/oz.

The Goldman estimate is that on a steady-state (into perpetuity) gold price of $US1400/oz Kingsgate should be trading at $11.65 and St Barbara at $3.98. Newcrest at $36.34, two weeks ago, was factoring in a gold price of $US1300/oz.

There are, of course, a series of assumptions, best guesses, and perhaps even a spot of tea-leaf reading, to form a view on the future gold price.

But, with the western world lurching from debt crisis to debt crisis, war in Libya, pressure building in the Middle East, and the oil price sitting comfortably above $US100 a barrel it is hard to not be optimistic about the outlook for gold.

Goldman has undoubtedly been far more scientific than that in its study titled "emerging value in the gold sector which, in the case of Newcrest, points to a "marked breakdown in the correlation between the gold price and Newcrest's share price over the past two months (since the eruption of unrest in the Middle East in mid-January)."

Having identified the breakdown in the link between the gold price and the share prices of gold companies Goldman could have jumped either way with its assumption.

Either the global market refuses to believe that the gold price can stay as high as $US1400/oz for long (the gloomy view), or share prices would inevitably rise to be more closely correlated to the metal they mine.

Gold haters, those people who subscribe to the "barbaric relic" argument of Lord Keynes would adopt the negative view and tip a sharp fall in the gold price to a level which reflects share prices.

Gold bugs go the other way, reckoning that share prices must eventually rise to reflect the higher gold price.

Multiple factors influence both share prices (such as asset and management quality) and the gold price (supply, demand and global instability). Having considered all that, Goldman produced a matrix which matched a selection of its favourite gold stocks, against a series of gold-price scenarios.

The conclusion was that Newcrest was considerably undervalued with a 12-month price target of $53. Kingsgate was targeting $14. St Barbara was targeting $3.90, and the fourth most favoured stock, Canadian-based Teranga, was targeting $3.50.

"Our recommendations are not predicated on appreciation in the gold price," Goldman told clients. "But identify potential for near-term re-rating to previous (price) levels."

All this is the view of one team of researchers, but it is a guide to the way investors have reacted to the gold price hitting $US1400/oz - in many cases they have ignored it.

Does that mean rush out and buy gold shares today. Perhaps not, if you believe the stock market prices are reflecting a future fall in the gold price - perhaps yes, if you believe the stock market has failed to keep pace with the gold price.

Either way, the Goldman research is an interesting look at how value gaps can emerge in markets which ought to be closely correlated - a sign that one side (or the other) in the equation must change.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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