southern cross equities:Gold equities.Prior to the recent fall...

southern cross equities:


Gold equities.

Prior to the recent fall in the physical gold price, there is no doubt that over the last 6 months domestic gold equities have been poor performers relative to gold. However that is the nature of the gold market. Considering the different fundamental drivers, physical gold is very much influenced by issues such as investment flows, ETFs and macro sentiment while equities are driven by production reports and earnings results. As a result physical gold and gold equity performance are often divergent.

However, after a period of consolidation, we believe the stars are aligning for another strong leg in the second stage of the current secular gold market. In addition, more importantly, we expect gold equities to outperform the physical gold price for a number of reasons.

Firstly the chart below highlights the significant underperformance of equities relative to physical gold over the short term. In the past this has often proved to be a trigger point for equity outperformance. We believe this is particularly the case considering the gold price in local currency terms is approx $A990oz which is close to the all time high. However, Lihir (LGL) has fallen 53%, Newcrest (NCM) is down 45% while Avoca (AVO) has declined by 40%.It is hard to remember a time when the gap between share prices and fundamentals has been so far removed from reality. At current PE multiples relative to past performance, domestic gold equities are pricing in a gold price in local currency terms of $A600oz or 40% below current levels. We believe genuine long term value has emerged.

Secondly with the next leg of the gold bull market, the major domestic gold producers LGL and NCM are both completely unhedged with 100% leverage to rising physical gold. Lastly the recent results from the major N. American producers have highlighted falling output in contrast to the rising production profiles of the local producers. As a result we anticipate a significant increase in industry consolidation.


Long term bullmarket.

If it appears we are negative on the outlook for the US economy then you are right. However we are not negative on the outlook for global economy with a few exceptions. In the short term there is no doubt Europe and Japan will struggle, however we remain firmly convinced the commodity-intensive BRIC economies and the developing countries will continue to grow strongly. In addition Australia has unprecedented leverage to this long term urbanization process.

However, despite the short term rally, we believe the US dollar remains in a long term downtrend driven by weak fundamentals for the US bond market and the economy. In addition the US Govt continues to exacerbate the weak fundamentals by printing money to alleviate the structural imbalances within the economy.

As a result we believe the gold, and other US-dollar commodity hedges, remain in a long term bull market. In addition we expect gold will make new highs above $US1,030oz and even inflation adjusted highs of $US2,250 before the current bull market is finished. Our big cap recommendation is Newcrest (NCM) and Lihir (LGL) while Avoca (AVO) is our preferred small-cap leverage.