04/02/2009 - 22:00

Signs bright as gold passes $A1,380/oz

04/02/2009 - 22:00


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IF Premier Colin Barnett is looking for places to find new jobs and boost the state's royalty income, he needs to look no further than the gold industry.

Signs bright as gold passes $A1,380/oz

IF Premier Colin Barnett is looking for places to find new jobs and boost the state's royalty income, he needs to look no further than the gold industry. Several local companies are straining at the leash to get new projects up and running, but face delays at government level in obtaining final approvals and Native Title clearance.

A collapse in capital markets is also hindering development of several projects, with smaller companies struggling to obtain finance from banks and new equity participants. Companies such as Integra and Catalpa have projects that are ready to go. They have second-hand gold processing plants in need of refurbishment and re-installation, but could be up and running by the end of this year, if the money was at hand.

Briefcase estimates that construction and operation of these two projects would immediately create 400 jobs, which might fall to around 250 once operations are established. It is time for the state to stand behind small companies like these two worthy candidates, in order to secure project debt. Mr Barnett would be creating jobs and ensuring a royalty stream of up to $10 million a year from these two projects alone, and could charge a fee for guaranteeing part of their debt. Sounds to me like the taxpayer would be doing a good job here.

Last year, Briefcase produced a rundown of gold companies and predicted that the gold price would rise to $A1,600 an ounce during 2009. So far this year the price has moved from a January low of just less than $A1,180 to about $A1,385/oz last week, which is up about 50 per cent from a level of $A900/oz last September. The current uptrend in gold is likely to be tested in the short term, but Briefcase believes that the long-term trend has now been established in the up direction, provided support at around $US880-900/oz holds.

While a move above $US900/oz level is seen as a milestone, more importantly, gold has hit all-time highs in euro and sterling terms and in Australian dollar terms is near all-time highs. Investors are seeking a safe haven for cash in the form of gold. Buying of gold backed, electronically traded securities (ETS) has proved to be a popular investment method. Operators of these gold ETSs, make a market in the securities and are obliged to buy physical gold to match the number of underlying gold units purchased, thus putting upward pressure on the gold price.

Physical purchases of gold as bullion or coin are also on the rise, with Japan's biggest bullion house Tanaka Kikinzoku Kogyo saying that sales of gold coins jumped 121 per cent last year as investors bought the safe-haven metal, although jewellery sales were weak and old gold in the form of scrap was seen returning to the market, particularly in India.

Gold mining is not as risky as some base metal operations. The mining operations are usually simpler, the metallurgy is very well understood and the final product can be sold forward or hedged to lock-in revenue, thus reducing financial risk.

With the lowest cost producers, such as Newmont and Dominion, showing cash operating costs of around $A400/oz and many others having costs well below $A700/oz, operating margins have expanded and profits will flow to shareholders, so long as pre-existing gold hedges don't get in the way.

Briefcase sees an ongoing surge of interest in the gold sector. Several of the Briefcase favourites have already moved since the November roundup, such as Perseus from 30 to 70 cents and Catalpa from 2 cents to 4 cents, but more upside is likely.

Even though the funding hurdle seems high in many cases, stocks that have not yet responded, such as Alkane, are worth watching, while those that have made some headway, such as Integra (IGR), Apex (AXM) and Avoca (AVO) are firm favourites for further appreciation.

It is not beyond reasonable speculation to see profits double in many cases and even triple from high-cost producers such as OceanaGold Corp (OGC), which looks set to rise to at least 60 cents per share from recent lows of around 20 cents per share. OceanaGold, started life as Macraes Mining and morphed into Gold and Resource Developments, subsequently GRD, before being spun-out and then taking over the Didipio copper/gold project in the Philippines.

The company is now entirely focused on its two New Zealand operations, where production is expected to total around 280,000 ounces this year as the Reefton mine ramps up to full production of around 75,000oz/year at total cash operating cost of $A650/oz. On the balance sheet, total debt of around $US185 million (including equipment leases) is offset by cash of around $US17 million.

The company is bringing on-stream, higher grade underground operations at the Frasers deposit at its Macraes mine and has integrated processing of concentrate from the Reefton mine in the north of NZ's South Island. OceanaGold employs high-pressure oxidation of its refractory gold concentrate to improve gold recovery, leaving its operating costs very sensitive to power costs in NZ's South Island, which in turn are dramatically susceptible to rainfall, since its power supply is all hydro generated.

Earnings during 2009 will be affected by a high level of gold hedging and option cover, which will constrain earnings growth, but also provides protection should the gold price fall. In 2009 and 2010, about 35-40 per cent of expected gold production is forward sold at about the company's cash operating costs, so a small loss on this proportion might be expected, but profits on the other 60 per cent will offset losses on the hedged proportion.

The company had a torrid 2008 as it sought to develop a gold/copper operation in the Philippines and had to write-off amounts associated with poorly configured hedge contracts. Operations at Didipio have been mothballed until the copper price recovers and the company is attempting to manage its remaining, low priced gold hedging, which leaves it unhedged in 2010 and beyond. Allowing for hedges in-place, pre-abnormal earnings this year could rise to about $65 million, which would be about 40 cents per share, based on 161.6 million fully paid shares and a bunch of options which are very much out of the money.

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With companies rushing to recapitalise following the recent economic train wreck, investors are being spoiled for choice as new investment opportunities swamp the market. New issues have come from a string of listed property companies, such as Mirvac and Macquarie Office, plus engineers like Transfield and now Wesfarmers, which is offering investors well-priced (some might say distressed priced) new shares. Institutional investors no longer need to enter the market to get set in good companies, since they are now buying wholesale, directly from the company at mate's rates.

This action is killing much of the day-to-day secondary market buying support. Briefcase expects this procession of primary issues to quicken as the reporting season hots up. Companies are most likely to raise new capital once they have reported earnings and have a fresh balance sheet to display. Several oil companies are also running low on cash, mostly as a result of delays, but also because of the low oil price. Briefcase notes that Otto Energy's broker has just issued a report valuing the company at 30 cents per share, using a very low oil price assumption, so I would expect a new issue to follow swiftly.

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Following big share price falls before the recent long weekend, brokers returned to their desks on Tuesday only to deal with a raft of fresh margin calls on their clients' margin loans. Encouragingly, despite the selling pressure normally associated with this action, the market lifted and only faltered slightly at around 11am.

The market's ability to clear margin selling and still gain strongly on the back of a recovery in resources and some financials, provides some encouragement that more normal conditions are returning. Briefcase wonders whether the margin lenders gave some latitude to clients considering the follow-on market lift in North America, but in any case, margin accounts will have been given some breathing space by recent action which should support further upward moves.

n Peter Strachan is the author of subscription-based analyst brief StockAnalysis, further information can be found at Stockanalysis.com.au


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