advertisement
In the stock market, you can be right on the long-term fundamentals but still get your head beaten in over the short term. Eventually, of course, those fundamentals will show themselves in the price of a stock. But until "eventually" arrives, your portfolio can take a painful pounding. Many investors who get the fundamentals right can't take the waiting and the pain. They sell long before a rising stock price vindicates their foresight.
That's exactly the situation that confronts investors in gold and other hard-asset stocks today. In the long term, the huge U.S. trade deficit, the huge U.S. budget deficit and the finite appetite of foreign investors for U.S. dollars will produce a weaker U.S. dollar and higher U.S. inflation. Gold, the hedge against a falling currency and rising inflation, will earn a place in more and more portfolios. With gold supply expanding only very slowly, gold prices will rise steadily. The great bull market rally in gold will resume after the recent correction.
In the short term, however, it's been painful to hold gold. The precious metal, which hit $725 an ounce on May 12, 2006, closed at $583 on Sept. 19. That's a drop of 20% in a little more than four months. And I can't guarantee that the metal won't drop another 7% to 10% or so. (Or even more, although I think that $540 an ounce would be about as low as gold will go.)
It has been even more painful to hold gold stocks. Freeport-McMoRan Copper & Gold (FCX, news, msgs) was down 21% in that period, Newmont Mining (NEM, news, msgs) was off 23% and Goldcorp (GG, news, msgs) was lower by 40%.
The defining difference
Yet while the sector was taking this beating, a handful of gold stocks tumbled by only half that or less. Anglo American (AAUK, news, msgs) was down only 10%, Iamgold (IAG, news, msgs) was lower by 8% and Kinross Gold (KGC, news, msgs) was off 4%.What's the key to the difference in performance by these stocks in the same sector? Bigger wasn't better. A bigger gold-mining company offers investors more safety because its assets are spread over more of the world, but diversified Newmont Mining, with operations in 10 countries from the United States to Uzbekistan, fell far more than relatively concentrated Kinross Gold (mines in four countries). Longer operating history? More consistent earnings or cash-flow growth? Stronger balance sheet? Low-cost production? No. No. No and no. In fact, some of the stronger performers were troubled companies going through wrenching reorganizations or just emerging from that process.
If the outperformers weren't bigger or better, what were they? Acquisition candidates. The outperforming stocks in the sector had the kind of promising but undeveloped reserves that would be especially attractive to bigger companies struggling to replace production from older deposits. The possibility that a company like Anglo American or Kinross Gold might be bought out by a bigger gold producer at a substantial premium supported their share prices and kept them from plunging as much as the shares of bigger companies that were potential acquirers.
More from MSN Money
What we've learned from gold
I think what investors have seen over the last four months in the gold sector can be stated as a general rule with four parts:- In a consolidating industry
- where big producers are having a tough time adding new reserves to replace current production, where the costs of discovery and production are climbing, and where the quality of newly discovered reserves is declining,
- smaller companies with undeveloped or underdeveloped reserves will become attractive acquisition candidates, and
- the shares of these potential acquisition candidates will outperform the shares of the potential acquirers.
I think these four terms describe what is happening today in the oil-and-gas and base-metals (copper, nickel and zinc) sectors, as well as in the gold sector. But the pattern is easiest to see in the gold sector.
Consolidation is taking place at an amazing rate. For example, Glamis Gold (GLG, news, msgs) launched a hostile bid for Goldcorp in 2004, which Goldcorp fended off by buying gold producer Wheaton River Minerals, which was followed this year by Goldcorp buying Glamis Gold in a friendly deal. Along the way Goldcorp paused to swallow some of the assets spun off by Barrick Gold's (ABX, news, msgs) acquisition of Placer Dome. That buying binge has pushed Goldcorp into the top ranks of the gold sector with 41 million ounces of proven or probable reserves. Barrick, meanwhile, has inched closer to industry leader Newmont and now trails in the reserves race by just 88.6 million to 93.2 million ounces.
Goldcorp paid a hefty premium for those Glamis reserves. At the share prices prevailing at the time of the deal, Goldcorp was paying, according to calculations by Canadian investment bank TD Newcrest, $659 an ounce (once you include cash cost and capital expenditures) for Glamis Gold's reserves. The traditional price for an acquisition in the sector is the spot price of gold, then about $625 an ounce. Looking at that premium, you can certainly understand why some investors believe Goldcorp overpaid, and why Goldcorp's stock price tumbled after the deal was announced.
Rate this Article
High