Leverage deserts SA gold shares

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Vladimir Nedeljkovic, ABSA capital and debt markets

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Leverage deserts SA gold shares
David McKay
Posted: Tue, 06 Mar 2007

[miningmx.com] -- SOUTH African gold shares have seriously underperformed the gold-backed exchange traded fund (ETF), known as NewGold, launched in November 2004 by Absa Corporate & Merchant Bank (ACMB).

A question now being posed is whether South African gold companies have suddenly lost their famed leverage to the price of gold. The debate is quite intensely argued.

A fascinating report by JP Morgan's Steve Shepherd, published on 22 February, said that since inception, NewGold had outperformed the South African gold shares by 25%. This is notwithstanding the gold bull market which has seen the rand price of gold gain 83% in the same period, and the dollar price by 57%, said JP Morgan. Compare this to how South African gold stocks have fared: a mere 45% higher in rand.

create gearing around gold ETFs

Shepherd said gold miners may have been mining lower grades in response to higher gold prices, a development that would destroy profit gearing in the gold shares. There's also the broader conclusion that consolidation in the gold market, at extremely large premiums, has helped destroy value and turned investors off and away.

Finally, it's argued, AngloGold Ashanti's overhang (its parent firm Anglo American has signalled its intention to sell the remaining 41% in the company) has had a negative effect on the South African gold index.

There may be reasons to think South African gold shares could return to vogue, but ETFs have cachet: "All this said, we contemplate how attractive it may be in a gold bull market to create gearing around gold ETFs through the use of derivative structures," said Shepherd in his report.

Vladimir Nedeljkovic, who works in ACMB's capital and debt markets and is at the front of the NewGold vanguard, said mandates frequently stop institutions from buying a call option on NewGold where investors benefit if the price of gold rises. "We are actively marketing the product. But there's always some inertia," he said.

For all its outperformance, NewGold hasn't set South Africa alight. An institution recently bought an additional 16,000 oz of NewGold, said Nedeljkovic. But in its two years' existence, total assets in NewGold stand at 340,000 oz, or R1.6bn in investment. "It's a question of mandate. A gold equity fund can only buy shares."

Internationally, the gold ETF phenomenon has blossomed. Streettracks, a product launched in New York through the World Gold Council (WGC), has notched up $10bn in assets. As such, it's the fastest growing ETF in history and the seventh largest in the US, said the WGC in a recent announcement.

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So while the immediate future for ETFs is secure in South Africa, at least in the short term, what's the future for South African gold shares? According to David Davis, a gold analyst for Credit Suisse Standard Securities, gold shares were merely waiting for the right conditions.

"I believe that the market is discounting gold shares significantly below the spot price of gold because they have not got their safe haven status," said Davis.

A sudden increase in the oil price, possibly to around $65/barrel, in turn owing to a political disturbance, would see gold shares win new favour, he said. "Gold shares tend to get bought on political fears, or bad economic news, and fears of inflation," said Davis.

Liston Meintjes, from Metropolitan Asset Management said the forward gold sales of some mining companies, such as AngloGold Ashanti, shows a negative correlation of company fortunes to the rising gold price. That's because hedge books were constructed several years ago for a falling gold price environment.

"It's the way hedge books (forward sales of unmined gold) are reported; there's a peculiar scoring. It looks as if you're losing the opportunity to make more money," he said. But he thought gold shares would report improved fortunes, just not in the short term. "Talk to some of the older analysts who've been around and they'll tell you: 'Look where the cash is going and where it's going to come from in the future. There will be some incredible improvements," he said.

Said a fund manager who asked not to be named: "It doesn't take a genius to see gold shares haven't performed. We're interested in buying gold shares this year."

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