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Gold has defied the naysayers predicting a bubble to burst and continued an upward trend with corrections along the way.  The price of gold has risen 27.7% year over year, benefiting many gold miners.  Here is a table of Australia’s top ten gold miners by market cap with their current share price and year over year price gain or decline:

Company (Code) Market Cap ($) Current Share Price ($) 1 Year % Change (+/-)
New Crest Mining (NCM) 33.65B 33.65 -17
*Perseus Mining (PRU) 1.3B 3.14 0
Medusa Mining (MML) 1.2B 6.65 +18
Regis Resources (RRL) 1.2B 2.94 +70
Kingsgate Consolidated (KCN) 954M 6.86 -35
Alacer Gold (AQG) 886M 10.83 +30
AngloGold Ashanti (AGG) 803M 9 -5
CGA Mining (CGX) 784M 2.35 -22
Resolute Mining (RSG) 786M 1.68 +27
St. Barbara Mining (SBM) 742M 2.28 -12

 

Obviously, a rising tide in gold prices has not lifted all these boats.  Recent market conditions have led to a chorus of calls claiming gold shares are cheap.  Are they?  Some of these shares have actually outperformed the price of gold.  Is it time to buy or should you wait awhile for another dip?  Should you sell what you have if you believe the world is in for big trouble?

In theory, the worse the global economic outlook gets, the higher the price of gold should go.  In addition, the rising price of gold should carry along with it the share price of companies who explore for gold and produce it.  Gold as a commodity has always been seen as an ideal hedge against currency losing value through either inflation or deflation.  When investors fear economic conditions will lower the value of traditional investments, they should flock to gold.

While rising gold prices tend to inflate share prices of gold explorers and miners, there are other factors involved.  The fundamental soundness of the company comes into play as miners with weak balance sheets may not survive a credit crunch.  In addition, in extremely difficult share market downturns, forced liquidation of gold mining shares to meet margin calls accelerates share price declines.

In practice, this is not always the case, as evidenced by the recent declines in both the price of gold and the share prices of many miners.  A recent increase in the margin requirements levied by the CME Group (Chicago Mercantile Exchange) for gold contracts saw the price of gold lose about US$100 per ounce.  It didn’t take long for the price to begin climbing again but the double-barreled bad news of the MF Global collapse and the possible demise of the long-awaited solution to the European debt crisis saw the price decline again at the beginning of November.

Yet as the market digested the implications of a Greek public referendum vote on the debt deal reached last week, the price began to climb again on 02, November.  

It would appear that gold does not always glitter as even its price is not free from the kind of panic selling induced by extreme fear.  Irrational fears can be inflamed by the sight or rioters in Athens and Occupy Wall Street protestors around the world, leading some to believe social upheaval may be so severe as to render even the most precious of precious metals pointless.

However, over time, the price of gold recovers as does the price of its producers.  As evidence, consider the following six month price chart for gold:

Note the high of $1900 in late August and the precipitous drop in late September.  Now compare the price movement against a six month chart for one of Australia’s hottest gold miners – Regis Resources Limited:

You can see that dips in the price of RRL roughly parallel the dips in the price of gold, as did the subsequent recoveries.  Even the most fundamental of fundamental investors should recognise that some technical indicators are in actuality quantifications of the market’s level of fear and greed.

The RRL chart includes the Relative Strength Indicator (RSI).  As you may know, the key levels of the traditional interpretation of the RSI are 30 at the low (fear) and 70 at the high (greed).  The red lines on the chart represent those levels and when the share price touches or breeches the line, a reversal may be coming.  Today most technical investors use additional measures to avoid false buy and sell signals, one of them being extending the limits to 20 and 80.  As you can see, the RSI did not accurately predict the September swoon.  However, if you look at the rest of the chart you can see the RSI does provide a rough indicator of which way the share price is headed.

Now let us use the same chart for the worst performer year over year, Kingsgate Consolidated, down 35%:

First, note that KCN hit a 52 week low in May and has been climbing back ever since.  The overall price movement is the same as that of RRL – when the RSI breaches the line or approaches it, a reversal follows.  The pattern also follows the overall price of gold.  

Considering these price movements, one could say that technical indicators as well as the overall price movement of gold provide a buy/sell/accumulate scenario for any investor.  If you already hold gold miner shares and you see the RSI approaching 70 or above, you may want to wait before adding to your position.  If you are a momentum trader, selling might be in order.  If you are a longer term investor, you could climb on board at any point after thoroughly researching the company fundamentals.

Such research could explain how KCN could perform so poorly relative to the others.  Its principal operations are in Thailand and the share price began its decline as difficulties with government oversight and regulation became an increasing concern.

While the risks posed by local governments are always a concern, during times like these a company’s debt position is critical.  Like it or not, there are things on the horizon that could make a GFC2 come to pass.

First, the situation in Greece is on a collision path with default.  While the proposed referendum may take weeks to happen, the Greek government may have fallen by the time you read this.  If a default occurs, no one knows for certain the size of the credit default swaps held against the debt.  The impact on issuers of the swaps could be catastrophic.

Second, with eyes fixed on Greece, what is going on in Washington remains under the radar.  The United States Debt Commission is to reach a conclusion on a long-term deficit reduction plan by 23 November.  If they do not, another downgrade of the US credit rating is likely.

Third, with real signs of slowing growth in China, can anyone predict the impact of economic chaos in Europe would have on their exports?

In short, a global slowdown and a credit crunch is becoming a possibility, although the odds are still low.  Should that happen the price of gold will soar, but even that will not be enough to help any gold miner in need of credit.  Let’s take a look at some financial performance indicators for these Australian miners.  We eliminated AGG because it is based in South Africa and PRU and AQG because they have not evolved from explorers to producers.  Here are the numbers:

  NCM MML RRL KCN CGX RSG SBM
Revenue ($) 4,114 138.5 107.9 172.6 219 464.1 364.6
NPAT ($) 908 102.8 36.3 21.1 60.6 59.7 68.6
Long Term Debt ($) 684 0 11.2 76 43.7 78.3 1.6
Gearing (%) 5.8% 0 21.7% 16.5% 24.4% 28.7% 2.8%

 

While additional research could identify solid opportunities in all these companies, there are signals here that make it easy to narrow down this treasure map to safer shares.  For example, KCN has long term debt (76 million) that is more than twice their NPAT and almost 50% of their revenue.  Even though they may be in a favorable position to restructure that debt and even though their gearing level is relatively modest, that is a big risk to take in the event of a credit freeze.

CGX and NCM also have substantial debt and RSG’s gearing level is uncomfortable.  Defensive investors might put them on a watch list for later consideration.

That leaves RRL, MML, and SBM.  Let’s look at some valuation ratios for these remaining shares.

  RRL MML SBM Sector
P/E 29.17 12.02 9.51 11.33
P/B 9.05 4.87 1.7 1.39
P/EG .19 10 .27 .47

 

To a value investor, RRL would be too expensive and SBM’s P/E of 9.51 makes it attractive.  On Price to Book RRL looks expensive as well but looking at the P/EG of .19 suggests the high price paid for anticipated growth may be worth it.

As you know, the P/EG is a forward looking estimate based on analyst estimates.  A P/EG of 1.0 represents a fairly valued price for future growth.  To explain how MML can have a P/EG of 10 while the P/EG for RRL is only .19, take a look at our last table – estimates for Earnings Per Share growth over the next two years, along with the actual number for the current year:

Earnings Per Share MML SBM RRL
2011 Actual (cents) 54.5 16.6 8.5
2012 Forecast (cents) 56.9 38.1 13
2013 Forecast (cents) 51.6 30.6 56.3

Note that analysts are predicting declines in EPS for both MML and SBM by 2013.  In contrast, they expect RRL to quadruple its earnings between 2012 and 2013.  Further research would show these numbers have to do with reserves and continued production capacity of existing mining operations.  Whatever the reason, this forecast goes a long way toward explaining why RRL has seen its share price rise by 70% year over year.

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