By Leo Larkin Investors in gold -- and in shares of companies that mine the yellow metal -- have received some conflicting signals lately. On Oct. 31, Barrick Gold (ABX) made an unsolicited offer to acquire Placer Dome (PDG), a move that would continue the industry consolidation of the past few years. (Placer has not yet responded to the offer.) Acquisition activity is usually a bullish sign for the industry.
We at Standard & Poor's Equity research raised our opinion on Placer Dome to 3 STARS (hold) from 2 STARS (sell) after the Barrick bid. (Our opinion on Barrick remains 3 STARS.) We also raised our 12-month target price on Placer to $21, from $15.
We estimate the combined company would have gold reserves totaling 149 million oz., and annual production of about 9.2 million oz. of gold. (It would also have significant copper reserves, totaling 6.54 billion lbs.) Also, the proposed merger would result in a much smaller exposure to production from politically dicey South Africa than Placer as a standalone company alone. We don't anticipate a rival bid.
But prices for the metal itself, as measured by gold futures, tell an entirely different story. On Nov. 1, gold futures plunged to a six-week low of $460.70 per ounce, below what technical analysts consider a key support level of $465. It was within hailing distance of another key support level -- $458 -- that some technicians believe will be bottom of the slide that has been under way since the yellow metal hit $483 two months ago.
DUAL ROLE. So are these good or bad times for gold investors? The recent price decline for the metal notwithstanding, our fundamental outlook for the gold subindustry is neutral, based on valuation of the stocks in the group. The S&P Gold Index was down 0.6% year to date through Oct. 28, vs. a 0.6% decline in the S&P 1500.
Gold occupies a unique position among asset classes because of its dual role as an investment -- chiefly as an inflation hedge -- and as a physical material used in the production of jewelry and certain industrial applications. The recent weakness in gold futures can be attributed to some easing of inflation fears as energy prices subside and central bankers in major industrial nations continue to raise rates to keep inflation at bay.
While we believe that the group's shares are fairly valued, we continue to have a positive view of the industry's secular prospects. As we see it, the longer-term bullish fundamentals remain firmly intact:
WIDENING GAP. First, we believe equity markets are less likely to offer as much competition for investment demand as they did in the late 1990s, when double-digit annual rates of return were the norm. While the stock market may have a positive return in 2005, we think financial asset returns in general will be less rewarding than during the 1990s. We believe erratic financial market returns will boost demand for gold and gold stocks.
Second, we see higher commodity prices in 2005 and 2006, reflecting consolidation in commodity-producing industries and continued global economic growth. The Commodity Research Bureau (CRB) Commodity Price Index rose 23% in 2002, 8.9% in 2003, and 11.2% in 2004. Through October 14, 2005, the CRB Index was up 15.4% year to date.
Third, we believe the gap between production and consumption of gold should widen as output stagnates and physical demand rises. We believe the low level of gold prices in the late 1990s led to sharply reduced exploration, which we think will result in flat to lower production even if the metal price rises dramatically.
DRAWING TOGETHER. Fourth, we believe that a cyclical decline in the U.S. dollar that began in mid-2001 will resume some time in early 2006. Also, greater volatility of currencies in general will likely increase the demand for gold.
Finally, the industry has undergone major consolidation, and the trend appears to remain viable in the wake of the Barrick-Placer news. Barrick acquired Homestake Mining in 2001, and Newmont Mining acquired Australia's Normandy Mining in early 2002. Mergers should, in our view, result in larger market capitalizations and more trading liquidity in the stocks. We believe this will make the group more attractive to institutional investors.
S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under the proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential vs. the expected performance of a relevant benchmark (e.g., a regional index such as the S&P Asia 50 Index, S&P Europe 350 Index, or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.
S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:
S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.
S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses, and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges, and provision from litigation or insurance settlements.
S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.
Standard & Poor's Equity Research Services: Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo.
In the U.S.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 28.7% of issuers with buy recommendations, 60.3% with hold recommendations, and 11.0% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.8% of issuers with buy recommendations, 44.8% with hold recommendations, and 20.4% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 28.1% of issuers with buy recommendations, 51.1% with hold recommendations, and 20.8% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 29.3% of issuers with buy recommendations, 57.7% with hold recommendations, and 13.0% with sell recommendations.
5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.
4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.
3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.
2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.
1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.
Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.
For All Regions:
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Analyst Larkin follows shares of gold mining companies for Standard & Poor's Equity Research Services