I have noticed that volumes are drying up and a number of precious metals stocks are suffering due to a lack of enthusiasm, and a shortage of new participants to take the ball up. Many gold bugs would be nearing the stage of being "fully invested", and until there is further evidence of the uptrend resuming with gusto we are unfortunately going to experience some lean times.
This is the period where many will throw in the towel, and feel that gold has failed them for not skyrocketing to $350 within a short timeframe. Investors must be mindful of the fact that bull markets tend to give you reasons to stay out, whilst the dreaded bear tends to suck investors in like a vacuum. We are all faced with serious decisions once the excitement subsides, and I guess those that no longer believe gold will ever rally still have a reasonable window of opportunity in which to exit.
My timeframe for precious metals has been pushed out somewhat, and I am resigned to the fact that it will be a buyers market for the immediate term. This period could extend for weeks, even months however there is enough short-term spikes in the junior end upon the release of drilling results with plenty to follow to keep some interest alive. Investors are becoming far more discerning, however there still appears to be interest from the daytraders, which has allowed some juniors to overshoot on the upside due to the sheer weight of volume. With increasing volatility, the risks of short-term trading after announcements have been exacerbated somewhat based on the evidence thus far of day two and three corrections.
The precious metals bus was over the legally allowed limit, and until we see some disembark, it is similar to a horse lugging 70kg in a sprint event.
Whilst the "noise has subsided" I have provided a basic overview of investing in the Australian gold sector.
The major discoveries of gold in the United States and Australia were made in the mid-19th century. The California gold rush started in January 1848 when gold was discovered in the tall-race of Sutter's Mill in Sacramento Valley. It is estimated that around 500,000 prospectors flocked to the region and the rush was accredited with opening up America's west. The first gold discovered in Australia was in 1851 near Bathurst, New South Wales and resulted in the areas transformation from what was essentially a penal colony. The great gold boom of the 1980's transformed Kalgoorlie and the region was affectively labeled the "Golden Mile".
Gold mining was carried out by the Egyptians around 2000 BC, however it is estimated that the production was no more than 1 tonne per annum. In the 15th century gold production in the region now known as Ghana provided a supply, which was estimated at 5-8 tonnes per annum. Russian gold production in the late 18th century was estimated to have reached 30-35 tonnes per annum, in 1847 (one year before the Californian gold rush).
Australian output peaked in 1903 at 119 tonnes per annum, and this level of production was not surpassed until 1988. During the majority of the 20th century gold production in many countries was in a period of decline, although the onset of the great depression brought higher prices in the early 1930's. The price rise of 1980 rejuvenated the industry and as a result a number of old mines were revisited and further exploration carried out.
In terms of investment appeal gold is often highly regarded as a source of diversification based on its negative correlation with other asset classes. The gold price is prone to supply/demand factors, the $US, interest rates, inflation and in some cases has been viewed as a safe haven in times of social unrest. The price of gold has tended to move in the opposite direction to stocks, treasury bills and bonds. With the US stock market experiencing a very strong period of growth over the last 20 years the price of gold has been effectively in decline, although there have been some powerful rallies during the "bear market".
One of the features of gold is its liquidity, and the fact it can be traded 24 hours a day in one or more gold markets on a global basis. It is easily convertible to cash, with transactions on the gold market similar to those in equities and bond markets.
Key Investment Considerations
What to look for in a gold stock
Understanding company reports
Due to rising exploration expenditure as a result of renewed interest in the gold sector, investors are more likely to be faced with the daunting task of deciphering company reports in terms of the exploration success/failure. Whilst a high-grade hit may cause a speculative frenzy, it may be at a shallow depth and may not be an accurate reflection of the potential resource. In other cases a relatively low-grade result might be at an excellent depth and indicate that a low cost mine could move into production.
There are three main types of drilling, and a brief description is provided below.
Rotary Air Blast (RAB)
Reverse Circulation (RC)
Diamond Core Drilling
Companies in their reports will usually state that they are conducting for example a 5000 metre RC drilling program, after conducting Geophysics which can include both airborne and ground studies. This will provide a very rough estimation of the costs involved, not allowing for the mobilising of rigs and staff.
Open cut or underground
Open pit refers to surface mining where the ore is removed from a pit. Underground mining results from access to the orebody achieved by a decline and as further ore is sourced the depth increases. The cost factors will involve underground power, water and essential services to facilitate the mining of the orebody.
In some cases where a significant discovery is made in a remote location, the ultimate costs will be affected by the need to develop roads, water and power supplies, living quarters for staff and access to air travel for staff which are normally required to work on a fly in -fly out basis.
Once a company releases exploration results, many investors who have little or no working knowledge of geology will often ask for various opinions on the grades achieved at certain depths. From my experience the higher the grade and the depth, the more excited investors become. Whilst 1m hits at 230 grams per tonne (g/t) may seem attractive in comparison to other results, it is often the shallow nature that may result in some apprehension over the continuity of the resource. Contained within results are the location of each hole, the type of drilling undertaken and a range of results received. For reporting purposes many companies elect to report "significant results" in summary before providing a more detailed review of the assay results. It is often one or two drill holes that fuel the initial speculative wave.
Solid results at depth such as 15m at 8 g/t that flow throughout a report will indicate that there is a greater likelihood of a continuous resource with impressive grades that may ultimately have an impact on production costs.
A resource may be reported as being 3.0 million tonnes at 6.2 g/t (Indicated) for 600,000 ounces of gold. A rough market capitalisation of this company will be based on the level of ownership of the project, access to infrastructure, the price of gold in both $US and $A. A back of the envelope calculation would result in a market capitalisation of around $9m, without including value for further exploration potential. If the company has 150m shares on issue, the valuation per share is 6c, however it should be noted that the liquidity of the company, location of the project and any external factors will result in wide ranging pricing discrepancies across the sector. If another company finds the resource attractive and also the regional aspect they may be willing to pay a much higher price per resource ounce to takeover the company in question. In Australia this has ranged from $20-$50 per resource ounce, with much higher valuations applied to resources in the gold producing regions in countries such as Tanzania.
The Green Room, A Guide To Speculating On The Australian Stock Market by Tony Locantro (2001)
The Mining Valuation Handbook, Victor Rudenno 1998.
18 July 2002
Tony Locantro is a client advisor in Perth, Australia, and the author of "The Green Room", A Guide To Speculating on the Australian Stock Market. Tony was previously a major contributor to Australian Internet forums under the nick "Budfox" from 1998-2001. Stocks mentioned in this article are for illustration purposes only and do not represent investment advice. The author has both direct and indirect interests in stocks mentioned in the article and these may change without notice.