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Globe and Mail quotes Stephen Takacsy on gold producers

After gold's brilliant run, is it miners' turn to shine?

MARTIN MITTELSTAEDT, The Globe and Mail,  7/26/2011

Gold prices are going through the roof, hitting a new record high this week above $1,600 (U.S.) a troy ounce, but you’d never guess it from the shares of gold miners.

Companies that actually mine the yellow metal are languishing. Many analysts and executives at gold producers say the stocks are becoming so undervalued relative to the metal itself that they’re due for a big bounce upward, but that increase has yet to materialize.

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Some market observers are even suggesting what might once have been unthinkable: that gold shares are becoming value investments, or compellingly cheap stocks with good prospects. “Today they’re absolutely value investments if you don’t believe the price of gold is going to collapse,” says Stephen Takacsy, portfolio manager at Lester Asset Management in Montreal.

Mr. Takacsy says gold stocks are so depressed they’re valued at levels that assume gold prices 30 per cent to 40 per cent below current market levels.

To see how much the shares have been left behind, consider Barrick Gold Corp., the world’s No. 1 producer. Back in late 2007, the price of gold surpassed $800 (U.S.) an ounce for the first time, and Barrick stock fetched around $45. Fast forward to today. The gold price has doubled, while Barrick’s shares are up less than 10 per cent.

Barrick isn’t alone. The performance of all the big gold company stocks “has been terrible,” observes Rob McEwen, former chairman of major producer Goldcorp and now head of US Gold Corp., an exploration outfit.

“We should be a lot higher. We’re lagging,” says Bruce Bragagnolo, CEO of Timmins Gold Corp., which operates a gold mine in Mexico.

Market history provides no precedent for this disconnect. Gold miners usually soar when gold rises, as increases in the metal’s price flow directly to the bottom line, greatly expanding profits because production costs don’t immediately increase while revenue does. In previous bull moves it was common for miners to rise 20 per cent to 30 per cent for every 10-per-cent increase in bullion.

Why the lack of upside this time?

The most common explanation points to the rise of exchange-traded funds that hold gold. This is the first bull move where investors who want to bet on the precious metal can buy bullion via an ETF instead of choosing to invest in the sector through mining stocks or bars of gold. (Buying the actual metal is cumbersome because it involves large amounts of paperwork, as well as storage and insurance fees, so it isn’t a popular choice except for diehard gold bugs.)

Consequently, the big inflow of money into the precious metals space has buoyed the price of gold, far more than the shares of miners. “So much money has been sucked into gold bullion ETFs ... they seem to be sprouting like mushrooms,” says Mr. Takacsy of Lester Asset Management.

Lester’s managers started getting interested in gold during the financial crisis in late 2008, viewing it as a hedge against monetary debasement. But despite having about $200-million in assets under management, Lester hasn’t purchased gold mining shares directly. It owns Claymore Gold Bullion ETF, as well as iShares S&P TSX Global Gold, an ETF based on a basket of senior gold miners.

There is a note of irony in the notion that ETFs undermine weaken interest in the miners. It was the gold mining industry, through its trade organization the World Gold Council, that established the first ETF as a way of broadening investor interest in the sector. “They created this product and the product has had them for lunch,” Mr. McEwen says.

Mining companies also have other strikes against them. Many big companies, such as Barrick, have made expensive acquisitions to increase output. Most gold stocks sport minuscule dividends, another knock. Also, resource nationalism has been rising around the world, raising the threat of increased taxes on mines.

Mr. Bragagnolo believes some investors are holding back on purchase of gold stocks because they fear a repeat of the 2008-09 financial panic, when bullion held up well but the shares tanked with the rest of the market.

With gold stocks not participating much in the rally of the commodity they produce, many analysts contend it’s only a matter of time before they do.

“This is a great buying opportunity,” says Ronald-Peter Stoeferle, gold analyst at Erste Group Bank AG in Vienna who primarily follows intermediate-sized Canadian-listed producers.

Mr. Stoeferle says the best opportunities lie in intermediate producers that are posting significant output growth and have mines in low-risk jurisdictions, such as Canada, Mexico and Chile.

Erste Group compiled a basket of about 10 of these intermediate companies in July, 2009. Its picks have on average doubled since then. Among the companies on the current list are Alamos Gold, B2Gold, Centerra Gold and Eldorado Gold.