MCO 0.00% 11.0¢ morning star gold n.l.

gold may be near top...... not says moi.....

  1. 1,702 Posts.
    Recent article by respected gold watcher Tim Treadgold.......

    Personally I think it's pretty typical contrarian stuff....

    How high can the gold price – and gold mining stocks – go in the current cycle? As the wider media focuses on the international gold price readying to break the psychological barrier of $US1000 an ounce, inside the industry there are signs some believe we're at the top already.

    Although gold bulls see $US1000 an ounce as just the start of a perpetual gold boom, realists see evidence of another story: central bank sales of gold are rising, investors are taking profits, and some miners locking in the record price by resuming forward sales.

    That is not to suggest that gold shares should be dumped, more a reminder that nothing goes up forever. The critical factors in gold company investment, like all other forms of resource investment, are the quality of the ore body and profitability of the mine.

    On those measures, the pick of the Australian gold sector are the two biggest miners, Newcrest and Lihir. After them there is daylight and a ruck of smaller and emerging producers, such as the resurgent Resolute Mining, and start-ups in Mundo Minerals and Apex Resources.

    Never an easy commodity to analyse or predict, gold is today being driven largely by its role as a global currency. It is, in effect, riding high on the collapse of the US dollar, the same game-changing event that has helped push the Australian dollar sharply higher and trigger wholesale currency-value realignments.

    But gold’s function as a safe haven in times of uncertainty will not last forever. A time will come when owners of gold will once complain about the fact that in its physical form it is non-interest bearing.

    As always, the most persuasive evidence that a gold-price peak is approaching can be found in the attitude of miners, the principal beneficiaries of a high price, and the people with most to lose in the event of a price fall. That’s why a changing attitude towards forward selling, or hedging, is an important test of what might lie ahead.

    Mercator Gold, the London-listed owner of the Meekatharra mines in WA, which once formed part of Alan Bond’s empire, is a small but important example of a changing attitude. Late last year it forward sold 35,000 ounces of gold, or 7% of its reserves, to lock-in a gold price of $A906 an ounce. With the Australian gold price close to $A1070, Mercator is giving up more than $A100 on each of those 35,000 ounces, but from the view of management it has protected its short-term cash flow.

    Mercator’s managing director, Patrick Harford, says his board had a policy of protecting short-term cash flow, particularly against the possibility of a “25% correction in the market”.

    “If you look at the charts, the likelihood of an 8% or 16% correction is very high,” Harford says. “A 20–24% correction is likely. It will be short, and sharp, and very good for the market, and likely to occur in the next six months.

    “We see it as a duty of care to protect our revenue in the short term. We don’t protect it in the long term, and we won’t ever be moving above 7% of our reserves.”

    Until recently that sort of view from a gold miner would have been the kiss of death, diluting exposure to a rising spot gold price. De-hedging has been all the rage so miners could catch the full effect of the rising gold price and appeal to investors, even if it meant incurring heavy initial costs.

    What's more, Harford is not alone. One of the local darlings of the gold game, St Barbara Mines, has also locked in a future gold-price floor by buying put options covering 1.5 million ounces of gold at an up-front cost of $A11 million.

    St Barbara chief executive Ed Eshuys says the put options protect the company’s revenue while retaining full exposure to any rise in the gold price. In effect, he has bought an $A11 million insurance policy, mainly to cover its development of the Gwalia Deeps mine near Leonora in WA.

    “We took the put option strategy to enable the development of our assets, and get an adequate return,” he says. “In the case of Gwalia, when the board made the decision to proceed we were only a $A400 million market-cap company facing a $A150 million investment decision and we wanted to be sure that we’d get an adequate return.

    “In buying puts at $A700 an ounce at that time for the life of the mine we did get an adequate return.”

    Now the comfort level of that original put-option deal written 18 months ago has encouraged St Barbara to go back to the market, this time looking to write more put options at $A800 an ounce or higher.

    Used in a practical way such as in Mercator’s decision to protect cash flow, or in St Barbara’s way to ensure funding and future profits, hedging represents a sensible business practice for miners exposed to sharp, and unforeseeable, moves in the gold price.

    However, what happened in the 1990s as the gold price fell is that hedging dominated management planning and was, in some cases, grossly overdone. The destruction of Sons of Gwalia was largely a result of forward selling too much gold. It is ironic that the namesake mine of that failed business is now the centrepiece of St Barbara, and the subject of a form of forward selling in the use of put options.

    Since the gold price started rising strongly it has been fashionable for miners to abandon or buy back their forward sales, largely because investors have demanded full exposure to the spot gold price. This has generated some spectacular short-term losses, but achieved the objective of making miners such as Australia’s leading gold producer, Newcrest, a more appealing investment because it has become a cleaner proxy for owning physical gold.

    It was a decision by Newcrest to restructure its $2 billion hedge book by repaying a gold loan that caused the company to book a $216 million loss in the December half-year, wiping out most of the benefits of the higher gold price, but leaving the company better exposed to the future price of the metal.

    That’s why Newcrest’s shares have more than doubled over the past 12 months, from about $19 to recent sales close to $40. Takeover speculation has added to interest in Australia’s biggest gold miner.

    Lihir also bore the cost of closing out its hedge book to book a loss of $US24.1 million for the year to December 31 despite a 25% increase in the underlying operating profit.

    Other big miners have been busy buying back their hedge books, but this worldwide trend is slowing partly because of concern about the future direction of the gold price, which has risen a long way in a short time.

    A reminder that investors and central banks (always the potential “spoilers” in a gold boom) are being tempted by gold getting at close to $US1000 came late last month when the International Monetary Fund re-floated the idea of selling 400 tonnes of gold, a small portion of its horde of 3217 tonnes.

    That possible sale came within days of two surveys of producer hedging. Both Gold Fields Mineral Services and the Dutch bank Fortis found that the pace of de-hedging had slowed sharply.

    Fortis found that the global gold hedge book fell by 2.3 million ounces to 26.8 million ounces in the final quarter of 2007, the 23rd quarterly fall in hedging. However, over the course of 2008 Fortis is forecasting that gold hedging will fall by 6–8 million ounces, compared with a total of 13.5 million ounces over 2007.

    The slower pace of de-hedging is partly a result of the declining amount of gold committed to hedge contracts. But, there is also evidence that gold producers are being tempted to close out their old hedge positions, and look at locking in the current high price.

    One of then newest gold producers, Mundo Minerals, has started life with full exposure to the daily gold price, which helps explain why its share price has risen from 26¢ to 94¢ over the past 12 months.

    But, that does not mean that a little bit of hedging is not a possibility. “It’s tempting, but not overly tempting at this stage,” says Mundo chief executive John Langford.

    “We don’t think we’re smart enough to pick the top of the market, and if we lock in too early under reporting guidelines we lock in our revenue stream and could face booking a loss. We prefer to watch the gold price, and take a view when we think it’s gone over the top.”

    Langford says he had looked at put options in a similar manner as St Barbara, but he would prefer to invest the cash required in Mundo’s mines that spend it on an insurance policy such as put options.

    For investors here are signs emerging that the gold price might have risen as far as it can in this cycle. The pace of producer de-hedging has slowed, as it had to, and some producers are using the high price to lock-in future cash flow.

    Watching what the miners do over the next six months will be critical to picking the gold price trend because any consistent pattern of fresh hedging means that the people mining gold reckon it’s time to protect their revenue. If you’re a gold stock investor you might consider doing the same.

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