By Tom Winnifrith | Monday 22 October 2012
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.
Golden Prospect Precious Metals (GPPM) is an investment company which invests in gold and silver stocks. Its chairman is the industry guru Malcolm Burne and his statement with today’s interims is a must read for anyone interested in gold and gold stocks. The financials themselves are interesting but it is the statement from chairman Burne that is of most note. It gives you a clear steer on which gold stocks to buy and which to sell as the sector splits in two over the coming year. Let me explain
During the six months to 30 June, gold prices were range bound beginning the year at $1,563.70 per ounce going up to $1,784.23 per ounce on 28 February and falling to $1,539.57 per ounce on 16 May before staging a recovery to finish the half year at $1,597.40 per ounce. This gave the investor a return of 2.16% in US dollars or 1.01% in Sterling terms. The NAV of the Company opened the year at 97.85p and finished at 77.67p, a negative return of 20.6%. As of today the NAV is 101.22p.
Clearly gold stocks had a rotten six months at the start of the year but with the gold price at $1745 the NAV has rallied.
Why though did gold stocks fall in H1 as gold prices rose? Burne ( who has a 40 year career in this area) does not mince his words:
“Shares in gold mining companies underperformed gold during the six months primarily due to lack of capital discipline and the pursuit of a growth strategy at any price. As a consequence, investors have expressed their disappointment and new Chief Executives have been appointed at five significant gold mining companies. I foresee greater focus on dividends and the shelving or deferment of expensive projects. “
This is fighting talk by Burne. Clearly two or three years ago it was easy for more or less any gold explorer to raise cash. But that cash has, in many cases, not been spent wisely. And that means that a) some CEOs will be fired and b) that it is very hard to raise equity for anything and more or less impossible to raise debt ( near term) for a capital project. And so it does not matter how many million ounces you have in the ground, if you do not have all or nearly all the finance need to build a mine already committed, you are toast. You will have to survive on a care & maintenance basis until the world changes.
That has clear implications for investors. Any stock in your portfolio which still needs to complete its funding in the next two years has a major problem. Any stock without a defined resource which needs cash merely to drill/pay its corporate overheads is toast. I shall be publishing a booklet on the 50 or so AIM companies that are in the latter category shortly – I agree with Burne’s analysis.
But oddly that still leaves both myself and Burne selectively bullish on gold stocks. Burne identifies the four key drivers of the gold price:
On the macro view, gold is and will remain the best insurance policy against:
(1) the global debt crises;
(2) the deflation to inflation cycle;
(3) geopolitical uncertainties with specific reference to Middle East situation and
(4) continued decline in the US dollar.
Additional factors include demand still outstripping supply, central bank buying reflecting a positive stance towards long term bullion prices, the large emerging markets still generating wealth creation with much of it being channelled into bullion.
And so the Burne analysis, which I share, is that gold prices will appreciate yet very few new gold projects will come onstream while output is in fact falling at existing mines ( mainly in South Africa). The physical supply demand imbalance thus assists the bulls at the same time as the investment case for gold is compelling.
And so Burne concludes:
An anticipated sustained appreciation in gold prices over the next few years will enable the better quality producers to generate increasing cash flows from which earnings will support stronger dividend policies at a time when the investment community is demanding better yields from asset allocation. Gold and silver shares as a consequence should benefit substantially going forward and some will be subject to healthy premiums from an expected rise in M&A activity.
I agree with the conclusion. How to play it? Buy buying shares in companies with large resources which are either in production or near as damn it and more or less fully funded. A company producing 100,000-200,000 oz per annum will a) benefit from those cashflows directly and b) is exactly the sort of mid-cap that will get hovered up in any M&A boom.
Or you could have a look at Golden Prospect Precious Metals itself. At 102.5p it trades at a tiny premium to NAV. Clearly you would rather by buying in at a huge discount but Burne’s baby is invested in the right sort of stocks and if his thesis is correct, and I believe it is, then the NAV will rise sharply and Golden Prospect may even start to trade at a large premium to NAV as a result. It would therefore be a fifth gold play to tuck away.
As to the sells - wait a couple of weeks for a long list!
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