Precious Metals:
Hoping for an
improvement
in the Fall
Precious Metals:
Hoping for an
improvement
in the Fall
Victor Flores, CFA
Senior AnalystPrecious Metals
HSBC Securities Inc.
Having
recently attended the Financial Times Conference, it is difficult not to
feel positive about the prospects for gold. This is not because the FT Gold
Conference is an unabashed love-in for the few remaining gold bugs on the
planet, quite the contrary, this conference (and the newspaper that sponsors
it) have in recent times been anything but friendly towards the precious
metal. The reason for the relatively upbeat mood is that even gold's detractors
can't find too many good reasons why the decline should continue, even though
there weren't too many speakers calling for an immediate improvement. Perhaps
one of the most interesting presentations was made by a representative of
the Austrian National Bank who reiterated the key role that gold continues
to play within the European central banking system. Contrary to the conventional
wisdom, he made the point that the European Central Bank was sending a very
strong signal by having as much as 15% of the bank's reserves in gold. The
reason that is significant is that the $50 billion euros that will be under
the direct control of the ECB are to be used predominantly to intervene
in the currency markets. Gold is not used for this purpose, and could have
been very well left out of the equation all together. The fact that the
ECB will hold as much as $7.5 billion euros worth of gold is noteworthy,
because it signals a strong role for the metal. He also put forth the opinion
that the ECB will exert a very strong control over the NCB's, making it
very difficult for them to dispose of their gold without coordination with
the ECB.
The
FT also put together an excellent panel on the infamous hedge funds that
have shouldered much of the blame for gold's decline. One of the speakers
expressed the view that only a small proportion of the 1250-odd hedge funds
invest in precious metals, and it appears that those that do were simply
taking advantage of a one-of-a-kind opportunity to profit from the uncertainty
surrounding the creation of the EMU. Even the experts were unable to quantify
the amount of gold sold short by the funds during this period, but there
is no question that it was facilitated by the abundance of central bank
gold available for lease. Fortunately, the pressure seems to have abated
and the hedge funds will now turn their attention towards other, potentially
more lucrative investment opportunities. As an interesting aside, several
of the speakers pointed out that the median hedge fund has posted rather
ordinary returns, despite their almost legendary prowess.
Despite
the much better tone of the conference (especially when compared with last
year's, which was particularly bearish) there continue to be some dark clouds
on the horizon. There is no question that central bankers around the world
will continue to find ways to earn a rate of return on their gold holdings,
which means that there will be no shortage of liquidity in the lease market.
This lessens the possibility of sharp short-covering rallies and provides
all the gold that hedgers and short-sellers might require. At the same time,
the financial intermediaries that help mobilize central bank gold are creating
new, innovative ways to create demand for gold-linked products. The traditional
gold loan is fast becoming a thing of the past, and is being replaced by
an all-inclusive package where the bullion bankers provide equity, debt,
and project finance. The use of derivatives helps bridge the gap between
borrowers who want low coupon, gold funding and the lenders, who may have
varying requirements as far as coupon, gold funding and the lenders, who
may have varying requirements as far as coupon, tenor, currency exposure,
etc. The facilities are being tailored for non-mining companies and are
being developed as much larger facilities (>US$250 million). The inescapable
reality, however, is that at the back of every such transaction is a sale
of physical gold into the market.
The
producers present at the FT Gold Conference, primarily the large producers
from each of the major gold-producing regions, painted a sober view of the
challenges facing the miners. Even the largest producers are feeling the
pinch of as lower gold price, and it is indeed re-focusing their efforts
on cost reduction and on large, low cost projects. The need for economies
of scale is becoming critical, especially for the largest producers, and
it is becoming clear that the mining fraternity is starting to learn how
to live in a world of US$300 gold. The number of projects in the development
pipeline continues fall as the lack of finance pushes them into the care-and-maintenance
category. Yet, despite the fact that many market players blame much of the
recent weakness on producer hedging, most mining companies remain steadfast
in their belief that hedging remains an integral indeed criticalpart of
their business.
Most
of the producers have responded quickly to the decline in the price of gold
and have taken measures to contain and/or reduce costs. The larger producers
have the flexibility to cut unnecessary spending on a number of items, and
have the economies of scale to necessary to negotiate more favorable supply
contracts. A few cheeky analysts would argue that most of these companiesto
one extent or anotherhave taken to mining higher grade ores in order to
bring their costs down. To take this particular line of reasoning a little
further, the reason for pushing costs down goes beyond mere reporting esthetics:
many of these companies could well stand to top up their treasuries and
a nice set of financials is indispensable before trying to go to market.
But we believe that merely accusing the companies of tapping into their
high-grade reserves is somewhat over simplistic. The largest companies have
consciously built their business strategy around large, low cost operations.
Barrick Gold has Meikle, Placer Dome has Pipeline, and Newmont Mining has
Yanacocha. Those companies that do not have a showpiece asset have had to
work very hard to drive costs down, and in many cases the results we see
today are the reward for programs implemented over the past two or three
years. Ashanti Goldfields is perhaps the most obvious case, although Homestake
Mining and Echo Bay have also achieved significant cost reductions.
Yet
the view we espoused several months ago has not changed. To wit, the gold
mining industry does not have enough capital for all the companies to do
all the things they say they are going to do. The frills will go first:
toll-free numbers, baseball caps, and conferences. But the shrinking pools
of capital will lead to further rationalization, including exploration budgets
and the development of new projects. The companies, in the meantime, hope
that every new season will bring an improvement in the gold price and an
improvement in the investment climate. Perhaps in the fall, they say. However,
unless the price of gold rises sufficiently to attract capital back into
the sector, the industry will continue to experience net outflows of capital.
The balance of power shifts further in favor of the largest, best-capitalized
producers, while the smaller miners will husband their resources until the
situation improves. Sooner or later those companies with cash will begin
the process of rationalization that is required before this sector can begin
a new rally. We continue to emphasize only those companies that continue
to thrive in this environment, companies with a proven track record of reserve
growth, low production costs, and a healthy balance sheet. Performance will
be driven by tangible, measurable results, and less emphasis will be placed
on exploration.
Notwithstanding
the difficult circumstances facing the industry, we retain our constructive
view. The gold stocks, which have been beaten up severely in the absence
of a sustained improvement in the gold price, are starting to look particularly
interesting. Many of the stocks are below the lows posted in the Dec 97
Jan 98 period, yet a handful of them can boast of an improving production
profile, low costs, and a healthy balance sheet. We would take advantage
of the current weakness to accumulate shares in the healthier producers,
including Barrick Gold, TVX Gold, Cambior, Iamgold, Samax, and Vengold.
Among the exploration/development group, we continue to like Crown Resources,
Sutton Resources, Metallica Resources, and Minefinders.
Editor's Note: Victor Flores, CFA is a Senior AnalystPrecious Metals HSBC
Securities Inc. (416) 947-2857.
|| TABLE OF CONTENTS || Bull & Bear Newsletter Digest || Bull &
Bear Reporter Featured Companies || Monetary Digest |
| The Bull & Bear Financial Report Copyright 1999 | All Rights Reserved Reproduction in whole or part is strictly prohibited without prior written permision NOTE: The Bull & Bear Financial Report does not itself endorse or guarantee the accuracy or reliability of information, statements or opinionsexpressed by any individuals or organizations posted on this site PLEASE READ DISCLAIMER |
Web Site Designed & Maintained by Estrada Design & Communications in association with THE BULL & BEAR INTERNET DIVISION |