San Gold Corporation

Cameron French

TORONTO — Reuters Monday, Sep. 14, 2009 08:25AM EDT

A 13-per-cent rise in a stock in about 10 days would normally tell investors it's time to take money off the table and wait for a chance to buy low.

Not so for the recent surge in gold equities: many see the big move up as the start of a more sustained rally.

Gold stocks, as measured by the S&P/TSX global gold index, have taken off in the early days of September, hitting their highest levels since last July, thanks largely to bullion's charge back up to the $1,000 (U.S.) mark.

Rather than predicting a retrench, analysts and investors are looking at favourable equity valuations, seasonal gold-buying trends, and the prospect of upward earnings revisions as reasons to expect further gains.

“I wouldn't take money off the table. I'd be more of a buyer than a seller,” said Ian Nakamoto of Toronto's MacDougall MacDougall MacTier.

Even if gold prices trade sideways or decline a little bit, Mr. Nakamoto sees value in gold stocks that have largely lagged bullion's rise of nearly 140 per cent since early 2005.

“I show them to be quite a bit undervalued,” he said.

RBC Dominion Securities, in a note last week, said top-tier gold companies – a group that includes Barrick Gold (ABX-T40.51-0.66-1.60%), Goldcorp (G-T44.25-0.23-0.52%), Kinross Gold (K-T23.92-0.41-1.69%) and Yamana Gold (YRI-T11.60-0.03-0.26%) – appear to be trading at a level consistent with a long-term gold price of $865 an ounce.

The long-standing view is that gold equities should outperform the metal (GC-FT1,000.70-0.40-0.04%) when it rises, as the miners' relatively fixed costs give them added leverage from a rising top line.

Soaring costs for oil, equipment and labour in recent years have reversed that relationship, leading to an equity sector that has stagnated at times, even as gold hit fresh highs.

But the retreat of oil prices from last year's peaks, along with easing inflation or outright price decreases on equipment, labour and other inputs due to the slower economy, have stoked optimism that cost inflation is coming under control.

“Fuel costs are still well below what they were in 2008, so that should help margins, and we've had some relief in terms of labour issues and … capital costs,” said Brian Hicks, who co-manages a resources fund at U.S. Global Investors.

Indeed, Barrick chief executive officer Aaron Regent predicted in late July that mining costs would decline over the next few quarters.

But for any extended rally in the sector, gold needs to build on its recent gains.

Gold finished the week just above $1,000 an ounce, the second time since March, 2008, that it has challenged – but so far failed to cleanly break – the $1,000 level.

Some might say the third time's the charm, but there are also compelling reasons why some expect a longer run.

Barrick, the world's top gold producer, perked up gold bugs when it said on Tuesday it will spend $3-billion to buy back gold hedges that had prevented it from realizing the full value of the recent rise in gold.

While the reason for the timing of the decision is still unclear, analysts say buying back the hedges at $1,000 gold only makes financial sense if the gold price continues to rise, suggesting that Barrick is banking on that scenario.

“Obviously their mandarins thought about it and looked at the gold prices and realized it's better to flatten the hedges than dig a deeper debt,” said John Ing, president of investment dealer Maison Placements.

To be sure, the bullish gold predictions are not unanimous, and in fact the excitement over the metal's strength is a sign to some they should tread carefully. In his well-known investment letter, Dennis Gartman said on Thursday the recent heavy media attention, combined with a large amount of bullish calls for gold, may signal that the metal has reached a top. “Our preference is to remove ourselves from the gold market until the smoke clears,” he wrote.

As well, Barrick has reportedly been buying gold on the market already to get rid of its hedges, which may have been artificially propping up the price.

But many see the metal's recent rise as a sign that inflation expectations, in the wake of billions of dollars in government stimulus spending, are prompting investors to turn to gold as a safer option to U.S.-dollar investments. Seasonal factors may also be at play, analysts say.

“Gold prices have almost always rallied in the fourth quarter … anywhere between 5 and 10 per cent on average,” said Salman Partners analyst Haytham Hodaly. “It's a great opportunity for us to crack ($1,000) and set a new bottom.”

The recent rise in the price also sets the stage for another possible bump for the stocks when analysts raise their earnings estimates on the gold miners, which have largely been based on gold in the low- to mid-$900s. “I think you'll see many people increasing their estimates,” Mr. Hodaly said.

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