Golds still have legs: Allan

In a series of reports released in June, Research Capital mining analyst Barry Allan takes a look at the gold sector and concludes it still has room to move higher.

First, he examines the relationship between the Toronto Stock Exchange’s gold sub-index and the gold price in Canadian dollars. Using available data, he develops a long-term trend line which demonstrates that “while gold equities have played catch-up of late, the index remains below its long-term trend line.”

This, he writes, indicates there is “room for further upside valuation, even without an increase in the gold price.”

Second, he examines the relationship between the U.S.-dollar gold price and the relative strength of the TSE’s gold sub-index, compared with the TSE 300 index, which serves to illustrate the value of the gold sector in relation to the valuation of the market as a whole.

It is clear, he writes, that the gold sector “remains at a relative valuation that is still below historical levels.” He adds that over the past three years, growth in technology and financial stocks has reduced the weighting of gold shares in the TSE 300.

“This means that the performance of gold shares relative to the market ‘should have been’ more dramatic,” Allan writes, concluding that “aside from the prospects for the gold price or the market as a whole, it still seems too early to be backing away from gold equities. We continue to recommend a minimum of market weight in this sector.”

Following up on the theme, Allan evaluates four mid-size North American gold companies.

– Glamis Gold (GLG-T) — Allan is “very positive” on the intermediate gold producer’s imminent merger with Francisco Gold, which is “creating the premier intermediate gold producer with dramatic growth opportunities.”

On June 12, Francisco shareholders voted 95% in favour of the merger.

Research Capital has revised Glamis’s underlying net present value to C$7.47 per share and raised its target price to $16 in the belief that Glamis “will continue to drive its share price to a mid- tier multiple of 2.15 times net asset value.”

– The “new” Kinross Gold (K-T) — The merger involving the “old” Kinross, Echo Bay Mines and TVX Gold is described by Allan as a “consolidation of mines without market viability” that creates a “premier leveraged exposure to changes in the gold price,” with “unparalled liquidity.”

The new Kinross will have interests in 12 operating gold mines, five of which will managed by the company.

Among the positive aspects of the merger, Allan cites better market visibility for Echo Bay’s and TVX’s top-performing mines, better positioning to compete for new assets, and management that is “second to none in knowing what appeals to the market and in communicating its strategic direction.”

On the downside, Allan cautions that the merger is non-accretive to asset value and that there are the problems owing to a lack of obvious growth prospects and low asset quality that exposes the company to risk from lower gold prices.

Allan concludes that Kinross will “reflect sentiment for gold and trade off changes in the gold price,” and will likely trade at an “extreme” multiple of 3 times net asset value. He recommends that Kinross be traded “nimbly”: when gold prices rise, sell, and when they fall, buy.

– Goldcorp (G-T) — The stunning production success of the Red Lake gold mine under the leadership of Chief Executive Officer Robert McEwen is being followed up by more positive exploration results, which Allan describes as “confirmation of our belief that more high-grade reserves may be delineated.”

In May, the company announced that the mine’s high-grade zone had been extended by an additional 87 vertical feet below the last reported drill intercept, potentially adding about 125,000 oz. gold to the resource base. Of note, one of these recent holes cut an eyebrow-raising 3.53 oz. gold over 58 ft.

Allan believes that the net result of the current drill program is that resources immediately adjacent to the known reserves will have been increased by 560,000 oz.

Allan views the exploration results as “positive” but cautions that “the potential for reserve expansion and continued excellent operating results are fully priced in the stock.”

– Eldorado Gold (ELD-T) — Research Capital is initiating coverage on the junior gold miner, which owns the operating Sao Bento mine in Brazil and the advanced-stage Kisladag and Efemcukuru gold projects in western Turkey.

Allan calculates that, at a long-term gold price of US$325 per oz., Kisladag is worth US41 per share, Sao Bento, US39 per share, and Efemcukuru, US9 per share.

Add to that various exploration and financial assets worth US39 per share, and Allan calculates that Eldorado has an underlying value of US$1.28 per share, or C$1.90. Shares currently trade at C$1.39.

He concludes that Eldorado is “an experienced gold producer with a very large resource base in Turkey that has a high likelihood of being developed.”