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Golden goose plucked

It’s an age-old argument – do gold stocks behave in the same way as the gold price?

Using Australia’s largest listed gold miner, Newcrest Mining, it is becoming easier to argue the negative in this debate as the operational heebie-jeebies keep tripping up this big company.

Much of NCM’s recent share price performance can be attributed to its own issues rather than the vacillations of the gold price.

The trend for NCM in the last two years has been for costs to keep rising, production has been stumbling and the average gold price received is stagnating. The outcome has been for revenue to decline and net profit to be crunched by rising cost of production.

NCM’s recent interim profit result revealed a net profit of $320m on revenue of $1.8bn that was down 23% on the prior comparable period. Gold production in the six-month period declined 18.3%.

A big part of the problem for NCM has been centred on its Lihir project in PNG where production has been hit be a series of equipment failure and weather interruptions. The $10.5bn acquisition in August 2010 has become a sleep deprivation issue for the company (and investors) which was slated to be delivering 1 million ounces of annual gold production by 2012.

The company has invested more than $700m in the Lihir Million Ounce Plant Upgrade (MOPU) but has received nothing but grief from the potentially glittering project.

Lihir was the central protagonist in the company’s most recent production guidance downgrade issued last week. NCM is now expecting FY13 gold production to be about 10% lower than previously thought to between 2.00-2.15 million ounces. Lihir could contribute around 620-680k oz of gold in FY13.

A chart of NCM and the USD gold price shows that while there are periods when NCM’s share price does track the direction of the gold price, as expected, the simple price performance measure over the last two years says otherwise. While NCM has declined by almost 50% since the end of March 2011, the gold price has increased by 9.4%.

Is NCM an isolated exception or do other gold stocks exhibit similar erratic performance suggesting a less-than-solid correlation with the gold price?

This chart includes a range of Australian, Canadian and US listed gold mining companies with the gold price performance included:

 Without exception from this admittedly selective list, every stock shown has underperformed the gold price over the last 12 months and so far this calendar year.

Part of the explanation lies in the factors that drive the gold price itself including demand for jewellery (particularly in China and India), central bank buying, investment (gold bullion and coins) and of course, the suppliers of gold – the gold mining companies.

There is a popular school of thought that gold is an inflation hedge but even that argument has lost some sway as nearly all the world’s central banks have swamped their economies with money to keep interest rates low. The resulting decline in the value of currencies has doused inflation to the point where it is very benign in most countries at present.

So is NCM a bad investment?

Perhaps for the short term it is but if the management team can rectify the very fixable operational issues, then NCM could deliver on its long term target of producing 4 million ounces of gold each year.

NCM has several large projects that could feasibly lift the company’s current annual production from just over 2m oz to the big number put forward and beyond. Copper production would also double in that scenario.

The balance sheet is also in very good shape with gearing at just 12.5%. NCM has accessed some very cheap USD debt last year at an opportune time. Nice work.

At under $20 per share, NCM certainly looks cheap but it needs a catalyst to improve sentiment towards the big miner. Improving its production profile would be an excellent start.

In the meantime, we would suggest investors still keen on the gold theme take a look at Silver Lake Resources (SLR). This stock has also copped a heavy beating but has the hallmarks of a very good gold investment – it has producing assets with a big development pipeline and its management and board has plenty of skin in the game itself.

A second option for gold bugs might be Sandfire Resources (SFR). This stock has been heavily sold off recently to the point where it must be back on the radar of its major shareholder OZ Minerals (OZL) which owns 19.6% of the company.

The market has been expecting OZ Minerals to acquire the rest of SFR as a means of utilising the significant cash sitting on its balance sheet of $659m as at 31 December 2012. SFR’s market capitalisation today sits at $852m.

SFR is due to report its quarterly production over the next few weeks, along with most other mining and energy companies. This may provide some further fundamental reasons for investigating this stock.

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