Wild Gold Price Swings Divorced From Supply / Demand Considerations
On Friday, Apr. 12, gold prices fell more than $80 per ounce to about $1,480. The sell-off, (some called it panicked, some said it was capitulation) means that in technical terms gold has, “broken down.” I am not a big fan of technical analysis. I have no idea where gold is headed next.
Over a longer period, I believe that simple supply / demand fundamentals will set the price of gold. Far less has been written on the fundamentals of gold compared to the technicals. That’s because short-term factors are clearly driving both the gold price and investor sentiment in gold company stocks. However, the underlying fundamentals should give investors some courage to buck the trend of selling and buy select gold companies.
Circling back to the title of this article, even flat demand, i.e. zero growth in demand for gold should support the current gold price Why? Because there’s going to be a gold supply crunch before the end of the decade. Taken together, resource nationalism, falling ore grades, fewer discoveries, cost inflation, longer permitting times and delayed / canceled green field projects are making it extremely difficult to bring on meaningful new supply.
That’s a long list of headwinds facing the gold industry. Each is very real and quite daunting. Therefore, gold companies with existing production, or those close to production will become a lot more valuable. Companies with strong balance sheets and low costs will become even more valuable. However, this will not happen overnight.
Majors such as Newmont Mining Corp, (NYSE:NEM) and Barrick Gold Corporation (USA), (NYSE:ABX) have not kept up with the 12 year bull market in gold. Newmont and Barrick failed to deliver shareholder value because they overextended for the sake of growth, at the expense of profitability. Barrick Gold Corporation (USA), (NYSE:ABX) just had its $8 billion Pascua-Lama project in Chile suspended. Barrick has a few billion sunk into the project and may have to walk away.
Newmont Mining Corp, (NYSE:NEM) lost a key gold mining asset in Uzbekistan several years ago. More recently it has faced troubles in Ghana and five protesters were killed at Newmont Mining’s Conga mine in July, 2012. Gold Fields, Goldcorp and Eldorado Gold are three more majors that have suffered in just the past few months.
Allied Nevada Gold Corp. (NYSEMKT:ANV) is a prime example of a very well positioned producer. I chose Allied because its shares have sold off more than any other mid-tier producer. The Company’s stock is down 68% from its 52-week high. That compares to 17% for SPDR Gold Trust (ETF) (NYSEMKT:GLD). Yet, investors need look no further than the Company’s late February corporate presentation to see that Allied has a bright future.
For example, Allied Nevada Gold Corp. (NYSEMKT:ANV) is tripling production by 2015 and the Company has 47.3 million gold equivalent ounces of reserves and resources at its Hycroft mine alone. Upon achieving a run-rate of up to 1 million gold equivalent ounces by the end of 2015, Allied will be comfortably in the bottom quartile on the global cost curve.
Allied Nevada is trading at just a 1x multiple of expected run-rate revenues at the end of 2015. I recognize that I’m referring to a period that’s 2.5 years years from now. However, the majors are trading at an average of about 3.5x revenues. Either Allied Nevada will see a substantial improvement in valuation or it will be taken out. I think it’s one of the best takeout candidates in the sector.
Conclusion
Even just flat demand for gold in coming years will support gold prices. If demand climbs due to the combined impact of population growth and urbanization, supply will almost certainly fall behind. Near term swings need not be over analyzed. Over the longer-term, gold prices are going higher. Existing producers like Allied Nevada Gold Corp. (NYSEMKT:ANV) are very well positioned for a robust rebound.
Peter Epstein has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
