SA precious metals shares a buy

Brendan Ryan | Fri, 08 May 2009 15:10

[miningmx.com] -- DRDGOLD got the March quarterly reporting season off to a good start with results that kicked its share price 9% higher on the day of release - and that could well be an indicator of developments throughout the sector.

Reasons include analysts' expectations of better earnings and cost performances still to come from South Africa's major gold groups, despite the fact that the March quarter is traditionally a bad one because the Christmas and New Year holidays fall into it.

There's also renewed bullish sentiment about the gold price, which seems to have turned up once more after dropping back to levels of the mid-US$800/oz. That positive sentiment could well rub off on the platinum price and shares. In fact, it already seems to have done so, with some analysts concerned platinum shares have already run ahead of themselves.

Aquarius Platinum (Aquarius) provides a classic example of the recovery trend in platinum stocks. Aquarius's price shot up almost 70% from around R22 in the middle of March to hit R37/share by mid-April, from where it's eased to around R32.

Aquarius announced a one for nine rights issue at end-March, pitched at R15,83/share, which was then an attractive discount. Its current share price makes a decision by shareholders to follow their rights a no-brainer.

Future movement in the two metals could well be linked

Future movement in the two metals could well be linked, says Paul Walker, CEO of British precious metals consultancy GFMS, which has released outlooks on both gold and platinum over the past month. The GFMS gold report released on 7 April predicted the metal could trade as high as $1 100/oz, driven by investor demand.

Presenting the platinum report in Johannesburg last week, Walker predicted platinum could trade in a range of $900/oz to $1 375/oz over the rest of this year. Walker said he didn't see any upside in platinum above that range because of the market surpluses in the metal, which GFMS predicted.

However, there was one possible factor that could change that.

Walker commented: "Investors who are long gold are typically long platinum as well. Typical trading patterns are that a firmer gold price will be favourable for platinum - so if gold meets our predictions then platinum could go above $1 400/oz."

The major development in the gold market since publication of the GFMS report has been confirmation of long-running speculation the Chinese central bank has been buying gold.

But as North American gold "guru" Martin Murenbeeld - chief economist at Dundee Wealth Economics - pointed out in his latest review, the amount isn't large because it involves just 454t over six years. However, the principle established is important. Murenbeeld commented: "It follows China could very well step up its purchases of gold reserves going forward as its concerns about the US dollar grow."

But Murenbeeld also acknowledged the possible downside for the metal. His latest "risk range" on gold is between $800 and $1 050/oz, as he notes the technical picture for the metal "looks fragile". He added: "The continuing improvement in economic and financial market sentiment takes away some of gold's safe-haven appeal."

The key points for SA's gold companies are that they're undervalued and Harmony and Gold Fields in particular are expected to deliver strong operating performances in terms of production increases.

RBC Capital Markets analyst Leon Esterhuizen says: "Current share prices still remain relatively low compared with forecast earnings over the next year - both from our own numbers and consensus numbers. "Based on current average consensus forecasts, SA's gold sector is rated on a forward earnings multiple of 12 plus. That's very low - close to the usual bottom of 10 plus - and seems to imply a market looking for a further decline in the gold price or expecting significant under-delivery on current management promises.

"The current forward multiples are so low we actually feel the sector is starting to offer a very good investment opportunity - even just as a short-term trade."

Esterhuizen highlighted the sharp contrast with the platinum group metals (PGMs) sector, where he said: "Forward PEs are well above 20 plus on average and where most of the major players are in fact expected to make losses.

"The PGM index, although having declined sharply since mid-2007, continues to trade as if sector profitability will be restored to 2006 levels. We believe that to be impossible in the absence of a significant increase in the PGM basket price. Too much of the potential good news has already been priced into these shares in our opinion."

DRDGOLD increased its operating profit 38% and dropped cash operating costs 5% as it shut down its loss-making ERPM underground mine and increased production volumes from its lower-cost dump re-treatment operations.

DRDGOLD CEO Niel Pretorius says production from the dump re-treatment operations is set to rise and more than compensate for the loss of production from ERPM as Ergo ramps up to full production.

Pretorius emphasises his cautious strategy continues to put a strong foundation under DRDGold's business and so avoid the violent swings this marginal producer has experienced in the past. He added: "We aren't rushing to do any deals at this stage. We have no desire to dilute shareholders."

However, he confirms September would be a key date for DRDGOLD. That's when its Ergo project should reach steady state production. "At that point we could look at a more ambitious approach."