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Picking The Right Gold Stocks

Australia | Sep 27 2012

– Gold is widely anticipated to benefit from more QE by central banks
– Production in South-Africa impacted by miner strikes
– Prospects for mature producers in South-Africa bleak
RBS warns not every gold miner is a good buy at present levels

By Greg Peel

It's difficult to find a major broker who doesn't currently have a gold price target in excess of US$2000/oz by next year or even earlier. The old adage is that if everyone has the same view on the market, the market will go the other way. However for bullish analysts, the upside story is just too compelling.

It's all about the inflationary effects of monetary policy stimulus of course, and in the case of USD gold, QE3 is the big driver. The USD gold price has stalled this week as concerns over Spain push the USD a little higher, but we did see a price jump of around US$100/oz in the lead up to, and confirmation of, QE3. At around the US$1750/oz mark we are still some way from the high posted earlier this year above US$1900/oz, and thus even further still from numbers over US$2000/oz. But in the meantime it would seem Australian-listed gold stocks have suddenly woken from their slumber.

Share prices of global gold producers have been lagging strength in the gold price for some time now, which historically is not unusual. If history is any guide, those share prices eventually catch up and even exceed their implied valued based on the gold price. And we must not forget that gold miners have their own problems with regard to costs of production, delays and so forth, which distorts any leverage to the gold price itself. Just look at the performance of Newcrest Mining ((NCM)) these past years.

Complicating the gold story at present is growing mine worker strike action in South Africa. South Africa is the fifth largest gold producer in the world but also the primary producer of platinum and paladium, and it is in the PGMs that South African strikes have first had an impact. Workers at Lonmin's platinum mines recently stage a walk-out which lasted six weeks and sparked serious violence. A total of 46 miners were killed, including 34 shot by police. In the end, Lonmin agreed to wage gains of up to 22%, or four times the South African inflation rate.

Not surprisingly, this “win” did not go unnoticed by workers in South Africa's other mines and mining companies. Citi has since upgraded its platinum and palladium price forecasts by up to 8% and 16% respectively out to 2016, warning of supply falling into balance with demand in 2012-14 and into deficit thereafter.

PGM prices will not soar to the heavens nevertheless as there will be a supply-side response as prices rise, Citi suggests. Higher prices will bring mothballed production back on line, see stockpiles drawn down, and encourage more recycling. However with costs rising all the time, South African gold producers won't have the same luxury.

Mine worker strikes have spilled over into South Africa's gold industry, currently halting around 39% of the country's output. Walkouts have occurred at many operations including those of majors Anglo-Gold Ashanti and Gold Fields as workers press for similar above-inflation wage rises. Global gold production has been on the decline for decades, underpinning the gold price. Production and consumption (mostly into jewellery) are not necessarily the most significant influences on gold – gold's value as a “currency” or store of wealth and thus a hedge against monetary inflation has reignited since the GFC – but their impact is fundamental nevertheless.

Wage increases in excess of 20% is not all South African mining companies have to worry about (and wage rises begin from a low base). The cost of electricity in South Africa rose 26% in 2011 after rising 25% in 2010. At the same time, legacy mines are slowly becoming depleted, forcing deeper and deeper and thus more costly production. It is anticipated that most mature South African gold mines will need to be downsized over the next one to three years.

Australian investors looking to play gold to the upside do have the option of buying units in the Perth Mint's exchange traded fund ((GOLD)) rather than taking a punt on gold miner stocks. However one must be aware the GOLD instrument is denominated in Aussie dollars so every rise in the currency offsets a rise in USD gold, and both are driven by a weaker US dollar.

If gold miner stocks are the investment of choice, RBS Australia warns many have already been for a run. All of Medusa Mining ((MML)), OceanaGold ((OGC)), Kingsgate Consolidated ((KCN)) and Resolute Mining ((RSG)) have jumped over 15%. Dependent on growth opportunities and leverage to the gold price, some Australian producers are now overvalued while others remain undervalued, RBS believes.

RBS has updated its gold price forecasts and as such adjusted ratings and price targets for Australian gold stocks under coverage. Number one pick at today's prices from the analysts is Alacer Gold ((AQG)), followed by Medusa, despite its run, and Perseus Mining ((PRU)), all of which retain Buy ratings from the analysts. RBS has downgraded OceanaGold to Hold from Buy and both Kingsgate and Resolute to Sell from Hold.

The analysts have maintained Hold ratings on both Newcrest and Regis Resources ((RRL)).

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