YOUR MONEY-Scary days panning for gold stocks

07/31/2013

By Chris Taylor

NEW YORK, July 31 (Reuters) - The scary movie "The Conjuring" may be a winner at the box office this summer, but on Wall Street the real horror show is the gold mining sector.

And the numbers have been as grisly as any low-budget slasher flick.

The Market Vectors Gold Miners ETF stands below $27, producing a year-to-date slump of more than 40 percent. Major producers like Barrick Gold Corp and Newmont Mining Corp sputter near 52-week lows, and the sector's average price-earnings ratio - a common measure of valuing stocks - is about 75 percent below its 10-year average, according to London-based ETF Securities.

After one of the strongest bull runs in stock market history, with the Dow Jones Industrial Average up roughly 150 percent from its March 2009 lows, apparently cheap valuations in gold stocks are hard to come by these days.

The sustained punishment in the stocks is not without reason. The falling price of gold - it stands near $1,315 an ounce, down from a high of over $1,900 in August 2011 - has made the industry's economics very tough indeed.

But some analysts wonder whether we have seen the worst and better days might be ahead for beleaguered gold miners. Hedge fund manager David Einhorn of Greenlight Capital, for example, said this week he is buying gold mining stocks.

"The numbers are so bad that they're good," says Carter Worth, chief market technician for New York-based boutique investment adviser Oppenheimer & Co. "There was euphoria at the high, when gold was $1,900 an ounce, and now there is total despair."

Since the entire sector has been whipped, Worth says it's futile to identify individual bargains amid the wreckage. Instead, he advises spreading the risk by sticking to exchange-traded funds like Market Vectors Gold Miners or SPDR Gold Trust.

Dangers abound. Since the industry is highly capital-intensive, many miners have loaded up on debt to help fund operations and launch new projects. That leaves them vulnerable in times of falling gold prices, economic contraction that crimps demand, and rising borrowing costs.

To avoid falling knives, Rick de los Reyes, a metals and mining analyst for Baltimore-based fund shop T. Rowe Price , suggests focusing on names that are not locked into massively expensive projects and have operating costs well below the industry average.

His favorite: Eldorado Gold Corp. The Vancouver-based firm has gold properties in Turkey, China, Brazil, Greece and Romania. It has net cash on its balance sheet and enjoys flexibility about which projects to push or table until the outlook for gold improves.

On the flip side, de los Reyes urges caution regarding Barrick because of its high debt levels - more than $14 billion in long-term debt at March 31 - along with a pricey menu of projects. Pascua-Lama on the border of Argentina and Chile, for instance, has been plagued by delays and cost overruns, with billions already sunk into development.

"They are in big trouble if the price of gold goes lower," de los Reyes says. That helps explain the stock's anemic forward price-earnings ratio of less than 7, despite an alluring dividend that has risen above 5 percent.

Another strategy to tamp down risk: Look to gold royalty companies, which own a piece of mine production without taking on operational costs. In exchange for upfront capital, they lay claim to an ongoing income stream generated by projects around the world. Such companies include Franco-Nevada Corp, Royal Gold Inc and Silver Wheaton Corp.

Don't expect an immediate turnaround in the fortunes of gold miners, though. Investors like clarity, and for gold miners, there is very little right now.

In their accounting, mining companies have to make certain assumptions about the price of gold. When it falls significantly, they have to go back to the drawing board and figure out which projects still make financial sense, and which do not.

"That process is going to take time," says Alec Kodatsky, a Toronto-based mining analyst for CIBC World Markets. "The upcoming quarter is going to be very important for that, but until then, people are going to remain on edge."

When sentiments do turn, though, gold mining equities could be a "very interesting place to be," Kodatsky says. His prime pick: Goldcorp Inc, whose portfolio includes mines in Canada, the United States, Mexico and Argentina. While trading at a premium to some others in the group, its growth prospects stand out in an industry where mines get depleted of their gold relatively quickly.

Meanwhile, he cites Kinross Gold Corp and Newmont as two stocks that could be underperformers because their playbooks may have to be rewritten if the price of gold does not rebound.

Even with so much carnage, Oppenheimer's Worth sees opportunities in the sector. "Everyone has been destroyed, so if you buy them now, there is limited downside if you are wrong," he says. "But if you are right, there could be a whole lot of upside."



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