Digging deep: a closer look at gold

(May 30, 2005) Although investing in gold is a highly-profitable endeavor for some, it remains a complete mystery to many investors. Adding to the confusion for would-be gold bugs is the way gold company shares behave. The sector isn’t delivering much in the way of performance, despite the fact bullion prices appear to be holding steady above the $400 mark.

Several executives gathered at a Toronto CFA society luncheon on Friday attempted to demystify the different aspects managers and analysts need to consider when looking at gold company offerings, such as mining operations and development, as well as the role gold can play in an investment portfolio.

Versatile and flexible management teams are critical for any mining company, says Stephen Walker, managing director and head of global mining research at RBC Capital Markets. “One of the things we cannot underestimate is good management.” He says good mine finders don’t necessarily make good chief financial officers. At the same time, a strictly numbers person might not appreciate the different laws, jurisdictions and regions a mining company needs to operate in.

As well, typical valuation metrics do not always apply to the companies. “It’s hard to determine upside potential,” he says. Metrics like adjusted market cap for instance don’t fully capture the huge financing needs gold companies tend to have. Similarly, he says earnings multiples are “not very useful. It’s hard to get normalized prices in this business.”

Steve Reid, executive general manager for Canada at Placer Dome, discussed the typical timeline and process for mine development, explained the physical and economic differences between open pit and underground mining and talked about the role of the World Gold Council in gold retail marketing.

Gold exploration, he points out, is a high risk operation from a finance point of view. “You need to kiss a lot of frogs to find the one that is going to turn into a mine,” he says. Recently, companies have been spending more on existing mines. Reid and Walker both say the way companies transition between the different phases of mine development from exploration and development to full operation and the level of cooperation that exists between the different groups running the mining company, technocrats and finance for example, are both important considerations for the would-be investor.

Poor management in the mining industry, says Walker, has destroyed more shareholder value over the years than it has created. “You need to have a strong management team to truly create value for shareholders.”

Martin Murenbeeld, chief economist at Dundee Wealth Management, rounded out the discussion with a technical analysis of gold and its relationship and reaction to different market movements. He forecasts gold will reach $450 by the end of the year.

In his discussion, Murenbeeld pointed out that gold is generally negatively correlated to financial markets. More recently however he says gold is moving more in sync rather than out of step with markets.

“You never quite know when you’re looking at a gold equity if it’s a proxy for gold bullion or just an equity behaving the way equities behave,” he says. “A technical analyst (would say) we’re a bit long in the tooth for this market.”

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com