While many gold analysts have been criticized by gold bugs for bailing out of gold in a big way in December 2003, Scotia Capital stands out among the usually conservative, bank-owned brokerage houses by taking a bullish view of the gold market for 2004.
In its booklet Focus 2004: Outperformers and Underperformers for 2004, Scotia Capital notes that gold typically doubles in value during periods of steep and stable yield curves (or rises 49% if outliers are excluded), except during periods when the U.S. dollar is extremely strong, as in 1975-1976.
And so with gold up only about 33% in the past 12 months, Scotia Capital reckons there is still plenty of upside in gold consistent with its price target of US$470 per oz. for 2004.
“Interestingly, the last time real interest rates were at current levels was in 1971, and over the following two years, the U.S. dollar weakened about 20% while gold soared five-fold,” states Scotia Capital.
However, in 1975, real interest rates were even lower, even though nominal rates had almost doubled to more than 6%, which presumably caused the U.S. dollar to strengthen while gold weakened for the next two years. At the end of the 1970s, with real interest rates still below zero, the U.S. dollar weakened significantly and gold increased five-fold again.
Today, the relationship between the weakness of the U.S. dollar and the rising bullion price is “irrefutable,” states Scotia Capital gold analyst David Mallalieu. “Therefore, providing that concerns over the fortunes of the dollar remain intact, we believe a gold price as high as US$500 per oz. could be attained in 2004.”
He cautions that “continuing positive economic news out of the United States could serve to mute or even force the gold price lower in the year,” thus creating a volatile bullion market.
But Mallalieu adds that any bullion-price volatility this year will not necessarily translate into more volatile gold-equity prices, since “any weakness in the gold equities resulting from non-company specific events is likely to be met by demand from the under-invested generalist portfolio managers or opportunistic specialists.”
While Scotia Capital is bullish on gold bullion and equities for 2004 and 2005, the firm believes mine supply will not decline by any significant amount until at least 2008. Comments Mallalieu: “The rapidity with which projects that were engineered, permitted, and then ‘shelved’ in the mid- to late-1990s and are now being brought to the financing stage has been truly startling.”
The bull market for gold could be over in two years, suggests Mallalieu, as, by that time, any of several factors could kick in:
— a cessation of reflationary pressures;
— a rise in the dollar;
— a preference, among investors, for financial assets;
— a re-adoption of anti-inflationary policies by central bankers.
“However,” adds Mallalieu, “we believe investors in bullion and gold equities have another 18 months to participate in the bull run before gold will regain some of the characteristics of a commodity and lose some of its ‘newly refound’ characteristics as a financial asset.”
Gold stocks are mostly overvalued using standard financial metrics, Mallalieu calculates, but “as long as the concerns over the U.S. financial system continue to be paramount, ‘excessive’ share prices may continue to be sustained.”
Scotia Capital’s top pick for 2004 among major gold equities is
“Tangible growth is one of the most compelling arguments for considering Placer Dome as a strong weighting in one’s portfolio,” states Mallalieu. “Foremost in the development pipeline is Placer’s 51% interest in the low-grade, bulk tonnage, copper-gold Cerro Casale project in Chile, the Pueblo Viejo deposit in the Dominican Republic, and its 60% share in the Cortez Hills project in Nevada.”
Scotia Capital has a 1- and 2-year target price of US$26.20 for Placer’s shares.
In Scotia Capital’s doghouse is troubled mid-tier producer
Mallalieu rates Agnico-Eagle a “sector under-perform” stock, and provides a 1-year target price of US$15.10. He says the company will probably show “substantially improved operating and financial results in 2004, but [that] these results are likely to be buffered by the recognition that the operating risk profile for the company may be higher than that of some of its peers.”
Also on Mallalieu’s mind is the prospect of “LaRonde II” — that is, the exploitation, sometime in the next decade, of ore below the existing shaft bottom. He projects a pretax internal rate of return of 11% for LaRonde II based on a gold price of US$425 per oz. and long-term zinc and copper prices of US45 and US90 per lb., respectively.
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