Gold Stock Premium at Low on ETF Demand: Corporate Canada

Investors are abandoning Canadian gold producers including Kinross Gold Corp. (K) for exchange-traded bullion funds, leaving valuations at a record low compared with the rest of the market.

Gold shares in the Standard & Poor’s/TSX Composite Index (STGOLD) fell 28 percent as of March 16 from an historic high in September, while the market benchmark is down only 1.5 percent. Miners in the index are trading for 16.7 times reported profits, or 12 percent more than the index. The premium is the smallest since February 2003, according to data compiled by Bloomberg.

Buying gold and ETFs tracking bullion prices such as the $69 billion SPDR Gold Trust (GLD) has become increasingly popular for investors as companies struggle to develop mines in remote locations and pay higher operating costs.

“In the past, they had to buy the equities,” said George Topping, a Toronto-based analyst at Stifel Nicolaus & Co. Gold ETFs “remove all of the technical risks” associated with mining the metal.

Kinross, the Toronto-based producer that last month took a $2.49 billion writedown on a Mauritanian mine and said it would delay projects in Ecuador and Chile, fell 15 percent this year through March 16. Gold gained 5.5 percent.

Agnico-Eagle Mines Ltd. (AEM), also based in Toronto, slumped 43 percent since Oct. 18, the day before it said a Quebec mine would close because geological conditions made it unsafe. The company took a $161 million writedown on the mine. Agnico-Eagle last month also reported a $644.9 million writedown on its Meadowbank mine in Nunavut Territory in northern Canada because of “persistently high” operating costs.

Premium Dissipates

“There’s been a lot of operational issues in the Canadian gold companies that have caused that premium valuation they used to receive to dissipate,” Craig Basinger, chief investment officer for Macquarie Group Ltd.’s Canadian private wealth unit in Toronto, said in an interview. The unit oversees about C$15 billion ($15.2 billion) of assets.

Seven of the world’s 20 largest gold producers are based in Canada. The premium for 38 gold companies in the S&P/TSX index has averaged 190 percent over the past five years, according to data on reported profits compiled by Bloomberg. The premium relative to forecast earnings has been erased, from 166 percent in February 2009.

Gold traded at a record $1,925 an ounce on Sept. 6 in New York amid concern the European debt crisis would slow global growth and on demand for the metal as a hedge against inflation. Central banks added 439.7 tons to reserves last year, according to the London-based World Gold Council.

Gold Declines

The precious metal declined 3 percent this month, trading at a two-month low on March 14, after the U.S. Federal Reserve increased its forecast for the world’s biggest economy and refrained from new actions to stimulate growth. The S&P TSX Global Gold Index (TTGDAR) lost 8.8 percent over the same period.

A resolution to the European debt crisis may end gold stocks’ underperformance against the commodity, said Jorge M. Beristain, a Greenwich, Connecticut-based analyst for Deutsche Bank AG. He recommends investors buy Barrick, Kinross and Vancouver-based Goldcorp Inc. (G)

Gold futures for April delivery closed at $1,655.80 on the Comex in New York on March 16.

Holdings (.GLDTONS) of the metal through ETFs have more than tripled in the last five years and reached a record 2,410.2 metric tons on March 13, valued at about $131.3 billion, according to data compiled by Bloomberg.

Record Earnings

Gold prices advancing for 11 straight years have helped producers report record profits. Cash flow from operations rose by an average of 33 percent last year, according to data compiled by Bloomberg Industries from nine gold companies.

Investors are skeptical that cash will be put to good use, said Deutsche Bank’s Beristain, citing acquisitions made in the past two years by Barrick and Kinross. Kinross bought Red Back Mining Inc. for C$8 billion in September 2010, giving it the Tasiast mine project in Mauritania. Kinross took the writedown on the mine 16 months later.

Red Back was “an absolutely, not just defendable, but a cornerstone acquisition for the company,” Kinross CEO Tye Burt said in a March 16 interview.

Most large producers are generating “strong” cash flow and earnings and the valuations of gold stocks will start outperforming “at some point,” he said. Gold miners plan decades into the future while investors focus on short-term results, he said.

‘Longer Time Frame’

“There is a need for companies to use a longer time frame,” Burt said.

Barrick declined 1.2 percent today to close at C$43.11 in Toronto. Goldcorp dropped 0.6 percent to C$43.38, and Kinross fell 1.2 percent to C$9.78. Agnico-Eagle declined 1.9 percent to C$32.80.

Barrick purchased copper producer Equinox Minerals Ltd. in July for C$7.3 billion. Companies producing copper and other base metals typically trade at a lower multiple of earnings. Barrick trades at 9.7 times earnings, down from 15.5 on April 22, the trading day before it said it would buy Equinox.

Barrick, which has the second-lowest price to earnings ratio in the 38-member S&P/TSX Gold Index, is trading at a discount to the S&P/TSX Composite Index. Investors are paying a 35 percent discount for earnings relative to the index, after paying an average 9.7 percent premium in the past five years.

Andy Lloyd, a spokesman for Barrick, declined to comment beyond what CEO Aaron Regent said last month in an interview. Gold stocks are heading for an “inflection point” triggering a rally after becoming increasingly cheap, Regent said Feb. 16.

Price-Earnings Ratio

Dale Coffin, a spokesman for Agnico-Eagle, declined to comment. Jeff Wilhoit, a Goldcorp spokesman, wasn’t immediately available to comment. Goldcorp CEO Chuck Jeannes said Feb. 27 at a conference in Hollywood, Florida, that the trend in gold stocks was becoming “unsustainable.”

Agnico-Eagle’s price-earnings ratio decreased to 10.8 from 26.4 on Oct. 19, when it said it would close the Goldex mine in Quebec. Kinross’s valuation ratio declined to 13.1 from 35.7 at the end of July 2010, before the announcement of the Red Back purchase.

Meanwhile, the so-called cash costs reported by mining companies -- their production costs minus items such as taxes and royalties -- climbed 24 percent in the past year, according to data compiled by Bloomberg Industries.

“We have seen operating costs and especially capital costs rise way above inflation,” Stifel Nicolaus’s Topping said.

Europe’s debt crisis is encouraging investment in companies whose earnings seem more certain, said Robert Cohen, who oversees $1.25 billion in precious-metals equities at Bank of Nova Scotia’s GCIC Ltd. unit.

Gold stocks will “eventually” turn around and start outperforming the metal, said Joe Foster, portfolio manager for the Van Eck International Investors Gold Fund at Van Eck Global in New York.

“Fundamentally, the current valuations just don’t make sense,” he said in an interview. “We’re just looking for a catalyst to make that happen.”

(This was the final story written by Matt Walcoff, who passed away last week.)

To contact the editor responsible for this story: David Scanlan at dscanlan@bloomberg.net

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