Safe haven in gold, says Paradigm Research
If you can’t handle watching Apple (AAPL:NASDAQ) drop from US$210 to US$145 in the space of a couple of weeks, the mining research team at Paradigm has some defensive ideas for you to think about:
“·We expect gold’s asset backing to shine amid market uncertainty. We re-iterate our $1100/oz one year target.
·Renewed focus on gold equities with strong cash flow and healthy balance sheets.
·Our Favourites are Yamana (YRI-T), IAMGOLD (IMG-T).
Honourable mention to Franco Nevada (FNV-T) and Agnico Eagle (AEM-T). We expect the gold price to outperform and play its traditional role as a safe haven in the current uncertain market. It is coming under pressure currently as speculative positions are unwound and it plays a role in providing liquidity, as it did in August 2007. Yet, if ever there was a time when gold’s asset backing should shine, it should be now, as the world’s central banks prepare to flood the system with liquidity. We re-iterate our $1100/oz one year target. If conditions become
unhinged, the upside could be substantially higher.
Yesterday’s sharp sell off in gold equities reaffirms that they are, after all, still equities and vulnerable to broader market swings. That said, we would expect the most liquid gold equities to outperform in a market being drawn into recession fears. We would also expect liquidity to remain paramount, the small stocks giving back their recent gains and underperforming further. Balance sheets will likely be scrutinized and cash flow is liable to regain the throne as king. With this in mind, we have looked at the largest North American gold stocks using three criteria.
1) Balance Sheet Strength, taking the debt minus working capital and expressing the net as a percentage of the market capitalization. (A negative percentage, therefore, means that the company has more working capital than debt.) All the major companies have relatively strong
balance sheets, with limited debt. Agnico and Lihir have the best. Barrick’s is middle of the road, unless one considers the remaining hedge, in which case it is the weakest.
2) Price to Cash Flow, basis consensus estimates for 2008 and 2010. IAMGOLD and Yamana have the best P/CF multiples
3) Share Price Performance. We look at the share price decline from 52 week highs, assigning the best ranking to the share price that has stayed closest to its 52 week high. (One could argue that we should do the opposite, i.e. look for the stocks that have sold off the most. We already have, however, a measure of value in the P/CF multiples.) Newmont has held its 52-week high best, followed by Barrick and Agnico.
Overall, we believe that the following major stocks are particularly well positioned for a down turn. We offer our thoughts, even though some are not officially covered by Paradigm.
Franco-Nevada (FNV-TSX, C$16.50, no rating)
Royalty companies like Franco are the closest thing to an ETF that one can find among the gold stocks. In Franco’s case its margin averages 89% because its royalties are, for the most part, a percentage of the royalty property’s revenue. As equity markets close down, more frequent and better quality opportunities to create royalties will present themselves to Franco. We like the business model because it is not limited to gold, but can include oil, gas and base metals. Franco’s main weakness is that it needs to raise equity itself. (We think $100m would position it well to snap up several bargains.) We have not attempted to rank Franco because
it is so different.
IAMGOLD (IMG-TSX, C$8.08, Buy, target C$16.75)
Strong cash flow, a strong balance sheet, but a share price that has underperformed its peers give IAMGOLD top rank in our simple test. IAMGOLD holds 149 Koz of gold at a book value of $330/oz. Unfortunately, it is not a name that enjoys the strong following that a Yamana (which ranks second) or Newmont (which ranks third) do. We expect IAMGOLD to report a record Q4/2007 in terms of production, cash flow and EPS and the company has some intriguing growth
prospects that are not yet acknowledged by the market (specifically Caiman, Westwood and growing niobium cash flow from Niobec). In a perverse way, maybe the stock’s lack of performance on the upside will shelter it on the downside. (Its share price underperformed the Intermediates and Seniors by 22% and 55% respectively, over the past year.)
Yamana (YRI-TSX, C$14.30, Buy, target C$20.00)
Strong cash flow, good growth and a medium strength balance sheet place Yamana in second slot in our simple analysis. We recently removed Yamana from our Top Pick index because of concerns that when it reports its Q4/2007 earnings March 25 it will fall well short of consensus, this being the first quarter for consolidating Meridian and Northern Orion. That potential pothole aside, the cash flow outlook is strong. We have heard recurring rumours that the company will do a financing, so we called the CEO last night. He re-iterated that there will not be an equity financing and that the balance sheet is plenty strong (as our simple test shows), especially considering the strong cash flow. Makes sense to us. Yamana is also the most liquid intermediate, by far, and turnover value was just shy of Goldcorp and Kinross yesterday.
Agnico Eagle– Strongest balance sheet, strongest cash flow growth, an average cash flow multiple in 2010 and the lowest sovereign risk among the major gold companies.
Lihir – The company must be thankful for the timing of its hedge unwind and major
capital raise in 2007. These have positioned it well for 2008.
Eldorado – In theory it ranked third best, but we feel constrained by the lack of
decision by the court about Kisladag.
Newmont – Strong cash flow and a solid share price performance of late.”