By Tim Wood –
NEW YORK (ResourceInvestor.com) — With some markets closed for May Day, gold and silver prices were hammered in New York trading. Yet related equities barely moved with a global set of more than 80 public companies losing an average of just 1%, even on low volumes.
It is the low volumes that have been worrying investors most. Daily volumes have, on some recent days, been running at less than half their three month averages. Monday was slightly better, but volumes were still almost a third off despite the background metal price action which saw a better than $3/oz gain on gold futures on Friday, and today’s June gold falling $5.60.
Yet something notable happened on Monday – the effective valuation of gold and silver stocks actually improved against a falling gold price.
It confirms once more that equities are reliable lead indicator given last week’s net decline in stock values relative to the gold price. With Monday’s turnaround there is now good reason to hope that the rot has stopped.
As at the end of April, it required the equivalent of 7,265 tonnes of gold to buy every listed gold and silver stock in the world. That was the lowest level since July 2003 and drew a line under weeks of sliding valuations as stock prices faltered. Precious metal equities have been ravaged since mid-March, losing about one-fifth of their value in aggregate since then, and nearly two fifths since the highs of last November.
The most apparent reason for the derating is the disappointment dished out by precious metal shares that have lately shown more leverage to the negative impact of rampant cost inflation than a stable high gold price.
Whilst the tonnes measure showed reasonably good value, it did not coincide as strongly as it usually has with another “matchbox” valuation method – market capitalization per recoverable reserve ounce.
The divergence began last October and widened with reserve values staying relatively high. That’s because the gold sector had lost reserves compared with a year before, but retained a lot of the market value baked into the old reserves. This is primarily a South African phenomenon with genuinely recoverable reserves having to be marked down sharply; not just because of shaft closures actual and threatened, but “below infrastructure reserves” no longer worthy of more than academic consideration.
There is some risk that valuations may not have completed a correction, especially with many financial ratios (price to earnings, price to cash flow, per share metrics etc) at historically high levels. At least prices relative to net asset values are modest compared with previous years.
If this is the turnaround, and some transaction minded industry executives have indicated that they are seeing value, then investors should prepare to be whipsawed.
Stocks have been thumped extra hard because gold exchange traded funds provided liquid havens to shelter from equity selloffs. It is apparent that some precious metal money managers have been using the gold ETFs to safeguard their funds. Indeed, simply track the gap between the gold ETFs and major gold equity indices to see how a little bullion could make a lot of difference to a mutual fund in the past half year.
Consequently, if investment professionals agree that the bottom is in, then equities might enjoy a rapid renaissance.
However, the long-term gains remain dependent on the ability of the companies to realize higher margins.
With cost inflation still tearing through an unprepared industry it may take a good while before that happens – unless the gold price finally breaks out and buys much more of the things it consumes.
The latest quarter-on-quarter inflation in total cash costs for the senior producers has risen 10%, which is the fastest pace in two years. If you strip out the anomalous data from two years ago, then the first quarter of 2005 was the worst cost inflation we have seen in the past 25 quarters. Worse yet, year-on-year inflation is running at 17%, whilst the gold price has risen only 6% in the same period. In the past 13 quarters production costs have declined only twice compared with the immediately preceding quarter.
When you throw in depreciation, sustaining capital expenditures, and exploration and development, it’s not obvious how most of the gold and silver companies can increase their cash balances without turning to the market for assistance.
Source: Resource Investor