Gold stocks slow to track bullion higher

DAVID PARKINSON

Globe and Mail Update

February 22, 2008 at 8:54 AM EST

As gold prices continued their march toward $1,000 (U.S.) an ounce yesterday, market watchers said the rally in the precious metal could still have legs for months to come. But the jury is out on whether gold equities can keep up the pace.

Bullion rose $11.40 to $949.20 an ounce on the New York Mercantile Exchange yesterday, its third consecutive record close, after reaching as high as $958.40 during the session. A falling U.S. dollar, oil-fuelled inflation fears and tight supplies have conspired to trigger another up-leg in gold's six-month bull run, during which time the metal has risen more than 40 per cent.

This week's gains, which have added $43 to the price of gold, have heightened expectations that the market will soon take a run at $1,000 an ounce, much in the same fashion as oil's charge at the $100-a-barrel barrier earlier in the year and again this week.

"We're not even close [to a top for gold prices]," said precious metals fund manager Charles Oliver of Sprott Asset Management, who said that based on historical prices relative to oil, gold could be headed for the neighbourhood of $1,700 an ounce. "[Investors] haven't missed the boat."

S&P/TSX Global Gold

A look at the relative performance of the S&P/TSX Global Gold subindex versus gold futures over the past year.

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National Bank Financial assistant market strategist Pierre Lapointe, whose firm last month raised its target for gold to $1,500 from $900, noted that unlike many other commodities, gold is still nowhere near a record high on an inflation-adjusted basis. That would be more like $2,200, he said.

But while many analysts think the $1,000 mark will fall, opinions are split as to whether the record price run translates into an opportunity for investing in gold equities. While analysts don't feel gold stocks are fully reflecting current price levels, they believe stocks are no longer bargains, as investors have increasingly embraced the high-price environment as the norm.

"The equities are starting to reflect the price of the commodity," said Tony Lesiak, mining analyst at UBS Securities Canada Inc. "The valuations are stretched."

On the surface, it would appear that Canadian gold stocks have significantly lagged the runup in the commodity price; the S&P/TSX gold subindex is up 23 per cent in the past 12 months, while the benchmark gold contract on Nymex is up 39 per cent. But once you take into account the sharp rise of the Canadian dollar over that time (the stocks are priced in Canadian dollars, the commodity in U.S. dollars), the stocks have actually gained slightly more than the commodity on a common-currency basis.

Yesterday, Mr. Lesiak cut his recommendation on Canadian gold miner Agnico-Eagle Mines Ltd. [AEM-T] to "neutral" from "buy," even as he raised his price target on the stock to $75 from $70. He simply felt the stock, which closed yesterday at $65.72 in New York, no longer had enough upside to justify a buy call.

That price target, however, is based on an assumed average gold price of $825 an ounce in 2008. The Street typically doesn't incorporate full value for a commodity price that is pushing to cycle highs, because they assume that the longer-term value of the mining assets underlying the stocks will be based on more modest commodity prices. Analysts' consensus forecast for gold this year is in the $850 range - and it's that price that stock valuations no longer look like bargains.

"But if I looked at it at $1,000, it's a different story," Mr. Lesiak said.

Even if gold can't sustain prices near $1,000 an ounce over the longer term, analysts still believe gold stocks could continue to get support from strong commodity prices for a few more months yet. They noted that historically, gold has remained strong in times of economic recession, typically peaking only toward the end of the downturn or as the economy begins to recover. The end of the gold rally typically coincides with the end of the Federal Reserve Board's rate-cutting cycle, which doesn't appear in sight yet.

"I think we still have several months yet to go," said George Vasic, UBS's chief economist and chief strategist.

National Bank's Mr. Lapointe said gold stocks don't have a strong history of gains during recessions; in fact, they have fallen an average of 12 per cent. However, they are outperformers relative to the broader market, which typically sheds 20-25 per cent - making them attractive havens for investors during market downturns.

Analyst David Haughton of BMO Nesbitt Burns noted that gold stock valuations have not kept pace with rising gold prices in recent years, largely because gold miners' costs have also risen sharply. However, he said that could change this year, which would help stocks.

"The gold price is rising faster than costs," he said. "The outlook for 2008 is for margin expansion."

But UBS's Mr. Lesiak said it's hard to assess what is fair valuation for mining stocks as long as prices are at levels the market has never seen before.

"We're kind of in uncharted waters here."