J.P. Morgan urges investors to buy gold for the holidays
J.P. Morgan analysts John Bridges and Steve Shepard recently advised,
“We’d be buying some gold for our Christmas stocking and Hanukkah gifts.”
Author: Dorothy Kosich
1 December 2008
J.P. Morgan metals analysts John Bridges in the U.S. and Steve Shepard in
South Africa said that while they realize the difficulties gold miners face,
"we feel they have probably underperformed enough for now, and we'd be
buying the gold space for the run into the holidays."
In a recently published commentary on gold, Bridges and Shepard advised that
"the tighter gold supplies and counterparty risk could give gold (and thus
directly the equities) a lift through year end."
Investment Thesis
J.P. Morgan's analysis suggests that "gold has shown two faces to the
market: gold equities have underperformed the S&P 500 since the beginning of
this financial crisis, but gold bullion has outperformed the general markets
handily. We continue to feel this results from the operational challenges
the gold miners face as a group but points to upside potential for gold
prices as mine supply continues to fall and now central bank sales
diminish."
While Bridges and Shepard noted that "our favorite technician feels the
dollar could strengthen further," gold should not "be simplified to being
the dollar not." They asserted that gold does diverge from its relationship
with the dollar "when the supply demand fundamentals for gold overcome the
prevailing (price) relationship with the dollar."
"We see mine supply continuing to fall and now, with central banks depleting
planned sales quotas, we expect official sector sales to fall quickly," the
analysts forecast. "Given the very large above-ground gold stocks, falling
supply does not guarantee stronger pricing, but it does, in our opinion,
create the right environment for stronger prices."
"We'd be buying some gold for our Christmas stocking and Hanukkah gifts,"
they advised. "We like the pure play on gold itself and also our Overweight
stocks Agnico-Eagle (AEM),Compania de Minas Buenaventura (BVN), Kinross (KGC),
Goldcorp (GG) and Newmont (NEM)."
Gold equities disappoint
Nevertheless, Bridges and Shepard expressed misgivings on the recent
performance of gold equities, noting, "Far from outperforming in a period of
economic weakness, the gold equities have disappointed against gold and the
S&P."
"We continue to believe that gold equities trade as a type of gold option,"
they suggested. "The size of the option is the amount of gold that underpins
each share, and the exercise price of the option is the ongoing cost of
production, which includes cash costs, maintenance capex and essential G&A.
...Option pricing models show that the exercise price is a key part of the
value."
"Option price = Stock price*Probability - (Exercise price times
Probability)."
The analysts said that it is reasonable to assume that the option value that
gold companies represent will deteriorate "via a rising exercise price (cash
costs) and/or falling ounces produced. We have one takeaway from industry's
problems, and that is that the gold price must increase."
Central bank sales to collapse
"We believe the price of gold was artificially low starting in the mid-1990s
as physical oversupply from the mines, central banks and forward selling
pressed down on prices. The lack of new discoveries suggests to us that
higher prices are needed to bring on new supplies," they advised.
J.P. Morgan's analysis concurs with that of GFMS, which expects central bank
gold sales to collapse. "The banks are now close to ending a second
agreement that limits total gold sales to 500 tonnes pa and with Germany,
Italy and France unwilling to sell, we expect gold supplies from this source
to fall," Bridges and Shepard suggested. "Now, with supplies falling (and a
weaker dollar), the bank sales are slowing.
Physical gold, gold leases
The analysts also suggest that "the gold coin and small bar market has
seized."
With the interest in gold growing, demand for gold coins and small gold bars
has grown. "Tight coin supplies could have added to the panic of some
buyers. Yet the gold price has been stable, and larger bars are still
readily available," they noted.
J.P. Morgan's research revealed that gold lease rates "have picked up
recently in an echo of the tightness in the coin market. ...We also
understand investors are switching holdings from unallocated gold (a general
liability of bullion banks) to allocated gold (a more secure custodial
holding).
From www.mineweb.co.za