Current gold stock valuations imply either a massive jump in cash flows or a much higher gold price is on the way

With gold over $1,200 an ounce cash is flowing into gold stocks but valuations are looking increasingly stretched

Author: Barry Sergeant
Posted: Wednesday , 02 Dec 2009

JOHANNESBURG -

Dollar gold bullion pushed for the first time through the US$1,200 an ounce mark overnight, once again fuelling heavy flows of cash into listed gold stocks across most of the world. At the fundamental value, valuations continue to look increasingly stretched, but market value levels are clearly not among any possible concerns lurking behind speculative trading of listed gold names at this point in whatever cycle the markets may be in.

Looking at the top end of the gold bullion producer heap, the aggregate market value of eight global Tier I gold diggers - Barrick, AngloGold Ashanti, Goldcorp, Newmont, Yamana, Kinross, Harmony, and Gold Fields - has now increased to US$163bn. These eight stocks produced a total of US$1.1bn in free cash flow (operating cash flow less cash spent on capital expenditure) during the first nine months of 2009.

This can conveniently be compared to the free cash flow from a single stock, Freeport-McMoRan, which for the first nine months of 2009 generated positive free cash flow of US$1.7bn. Happily this stock is seen by the majority of investors as something outside the bubbly classification of gold stocks. It happens to rank as the world's No 4 gold miner, but focuses on copper, where it is No 2, and also molybdenum (No 1) and cobalt

Freeport's market value is a mere US$36bn. If the eight gold stocks mentioned were merged into a single entity, all else being unchanged, the comparable market value would be, as mentioned, US$163bn. For the uninitiated, that looks like about US$100bn worth of froth. Based on the same metrics, if BHP Billiton, the world's biggest resources stock, were a gold stock, its market value would be US$665bn, rather than its actual US$201bn. That's a gap of nearly half a trillion dollars.

In the listed gold stocks arena, the astonishingly high multiples imply either that the gold stocks mentioned are going to produce exponential increases in free cash flow going forward, or that the dollar gold bullion price is simply going to continue rising to levels considerably higher than US$1,200 an ounce.

The flip side of this happy equation is that when the dollar gold price loses momentum - and that day will come - the downside for listed gold equities could be long and slippery and jangling for nerves of tungsten. Memories may be short, but Barrick, the world's biggest gold digger by value and production, saw its stock price swoon during 2008 from above US$50.00 to around the US$10.00 a share mark. Froth has now swept it upwards, where it is once again approaching the US$50.00 mark.

There are slight signs of risk aversion. Leaving valuations aside for a moment, there is strong and broad demand for the majority of global Tier I and Tier II gold names. Lagging somewhat in the heavyweight league are Harmony, certainly, and also Kinross, Zijin, Gold Fields, and Polyus. At the Tier II level, Simmer & Jack is lagging terribly (not least on a management drama looking increasingly insane); good relative value is offered by Agnico-Eagle, which has apparently been price-primed for a fresh capital issue to shore up its balance sheet.

The Tier III level is much more of a mixed bag; distinct losers include two South African counters, DRDGold and First Uranium (afflicted by the same executives who control Simmer & Jack), and names exposed to Venezuela in the form of Rusoro Mining and Crystallex(which shot up by 43% overnight in Canada, giving a taste of the kind of speculative mania that continues to envelop so many gold stocks).

Over the past month or so, there has been some meaningful "swaps" among stocks involved in gold exploration and development. Some older favourites are back among the front runners, in the form of the likes of Gabriel, Timmins Gold, Mineral Deposits, Alamos (always one of the coolest no matter how hot it gets, what with mines and projects like Mulatos, Agi Dagi & Kirazli ), Andean, European Gold, Kirkland Lake, and Novagold. Relatively fresh names in the new fangled gold rush include Loncor Resources, Tyhee, Kilo Goldmines, Kryso Resources and Vista Gold.

During this kind of mania, a point arises sooner or later when the wreckage starts to gather in the fast lane, no matter how small the debris. Some have the ability to get back on the searing roadtop and continue the journey. There are a bunch of stocks that have risen by 1,000% and more from low points over the past year - and remain more than 1,000% above those low points. Profit taking has set in; something that could change in a few seconds, given a luck-drenched fast stop in the pits attended to by a crew who best know how to get the patient back on the highway, with or without visible evidence of wear and tear.

Such names include Norseman Gold, Century Mining, Terrane, La Mancha Resources, Atac Resources, African Gold Group, Mariana, Sandfire Resources, New Dawn, Mirasol Resources, Tara Gold, Archipelago, Ventana Gold, Australian Solomons, Medoro Resources, Underworld Resources, Frontier Mining and Yukon-Nevada Gold.