Gold stocks are ‘dirt cheap’ – JP Morgan

[miningmx.com] — GOLD stocks are dirt cheap and gold is going to $2,500/oz by the end of the year – that’s the highly bullish view of JP Morgan Cazenove as stated in its recently published SA Gold Foresight.

Analysts Steve Shepherd and Allan Cooke commented: “Gold shares have performed miserably relative to the metal in a weak equity market environment.

“Given the improved outlook for cash flow margins, gold shares are cheaper than we’ve ever seen them. Consequently we see our gold share picks outperforming the metal/ETF (exchange traded fund) on a 12 month view.’

Biggest winner in the latest rankings is DRDGold where the analysts have revised their investment rating from underweight to overweight.

Other gold shares which they have rated as overweight choices are Hamony, Gold Fields, Randgold Resources and Koza Gold, which is a junior operating in Turkey.

According to the JP Morgan report South African gold shares were trading at an average discount of around 50% to the analysts’ revised DCF (discounted cash flow) valuations on a spot basis.

The firm has raised its “long-term real gold price forecast’ from $1,150/oz to $1,300/oz based on its assessment of the all-in cost of replacement ounces.

JP Morgan expected gold to average $1,709/oz in 2011 and $1,869/oz in 2012. The firm expected the gold price to pull back slightly in 2013 when it predicted gold will average $1,750/oz.

“We see investment and emerging market central bank demand as the primary underlying drivers of increased gold demand,” said the analysts.

“Negative real interest rates in the United States; on-going geopolitical risk in Europe and bloated central bank balance sheets remain supportive of higher gold prices, in our view.’

A key factor for the SA gold producers is the rand/dollar exchange rate which can dramatically affect the rand revenues received which are booming at the current gold price of around R440,000/kg.

The analysts said they continued to factor in a weaker rand for the long-term – given the structurally high inflation outlook for South Africa – but they have actually strengthened their exchange rate assumptions for 2012/13.

The end-2011 spot rate has been revised to R7.2/$1 (previously R7.3/$1) which is anticipated to depreciate by around 10% to R7.90/$1 (previously R8.4/$1) by the end of 2012.

Those exchange rates set against the new dollar gold price forecasts give an average rand gold price assumption of R382,571/kg for 2011 – up 18% on JP Morgan’s previous forecast – rising to above R450,000/kg for 2012/13.

TOP PICKS

The analysts identified Harmony and Gold Fields as their “top picks”.

They commented: “Harmony is the least expensive South African gold major on our numbers.

“It remains the riskier gold share, as the group is highly geared to the rand gold price, with relatively slimmer free cash flow margins that are more at risk to a stronger rand/dollar exchange rate; safety related production losses and relatively high SA cost inflation.

“The higher gold price and improved cash flow generation puts the Wafi-Golpu project well within reach for the group in our view.

“Its rating has benefitted from positive news flow on the Wafi-Golpu project but the market has yet to fully factor in the substantial upside potential in Papua New Guinea in our opinion.

“Our base case model for Golpu – ex Wafi – contributes around R39 a share.’

Turning to Gold Fields the JP Morgan analysts said’: “Gold Fields’ rating remains undemanding on anticipated improving operational performance at a higher gold price and we maintain our overweight call.”

The analysts expected both Gold Fields and Harmony to outperform AngloGold Ashanti in a rising rand gold price environment.

“AngloGold is not cheap relative to its local peers. Quality assets, capable management and healthy cash flows are reflected in a premium rating of around 30% on our base case assumptions to its major peers in the SA gold sector.”

– The writer owns shares in Gold Fields, Harmony and DRDGold.