Why gold stocks are on the rocks

Invesco's Norman MacDonald cites rising costs, margins squeeze.

Sonita Horvitch 24 April, 2013 | 6:00PM

Norman MacDonald, a vice-president and portfolio manager at Invesco Canada Ltd. who specializes in resource stocks, says that the ongoing volatility and weakness in gold stocks reflects both the sharp drop in the bullion price and the cost challenges facing gold-mining companies.

"Gold bullion has been taking it on the chin," says MacDonald. There are a number of reasons being offered for the heavy sell-off in this precious metal, he says. There is the thought, for example, that some investors "are of the view that the world is successfully sorting out the mess caused by the 2008-2009 global financial crisis and that threats of a resurgence of inflation are overblown."

As part of the disaffection with bullion, MacDonald says, there has been a mass exit from gold-bullion exchange-traded funds. These ETFs, in turn, are "being forced to liquidate their bullion." This is pushing down the price even further, he notes.

Then, he says, there was the scare that the European Central Bank would require financially strapped Cyprus to sell its gold reserves and that this might lead to further sales by central banks of troubled Eurozone countries at the behest of the ECB.

Whatever the reasons for the latest bullion sell-off, it's evident "that retail investors are seriously questioning the value of gold as a traditional safe-haven investment." The irony of this "capitulation in gold bullion," says MacDonald, is that there remain considerable uncertainties afflicting the global economy. "The macro environment should presage a bright time for this asset."

Gold stocks have been hard hit by bullion's price decline, says MacDonald. "This is putting a further squeeze on gold companies' profit margins, which have already been under pressure due to rising costs." They are also facing an array of challenges in bringing some key resources on stream. The result, he says, is that valuations on these stocks have fallen to levels which "I have not seen in many years."

 
Norman MacDonald

While the drop in the bullion price has also affected industrial commodities, they have managed to hold up relatively well, says MacDonald. Still, he says, base-metals stocks, like their gold counterparts, are generally out of favour.

"There have been some bright spots in the materials sector," says MacDonald. For example, forest-products stocks have done well over the past year, he says, buoyed by the perceived improvement in the U.S. housing market. MacDonald reports that he has been taking profits in holdings in this segment.

Turning to energy, MacDonald notes that natural-gas prices, which have been languishing at historically low levels for some time, put on a spurt this year. Also, the Canadian oil-price discount to U.S. and European benchmark prices has narrowed, "although the stocks are not yet reflecting this." The narrowing of the discount is a positive sign, he says. "But there still needs to be enhanced infrastructure to allow western Canadian oil producers to get their crude to markets."

At Invesco, MacDonald is responsible for managing approximately $2.3 billion in assets. His Canadian mandates include Trimark Resources and Trimark Energy Class.

At the end of March, Trimark Resources ($315 million) held some 67% in Canadian companies, 17% in U.S. companies, 12% in international companies and the remainder in cash. When it comes to key sector holdings, the fund, with 42 names, had some 20% in gold at the end of March, 12% in diversified metals and mining, 41% in oil and gas companies and 7% in energy services.

Of his gold holdings, MacDonald sold his long-standing position in the major global producer Barrick Gold Corp. ABX at the beginning of April. "I became increasingly disappointed with the company's corporate governance and had concerns about its capital allocation." For example, Barrick's acquisition of the copper miner Equinox Minerals Ltd. in 2011 has led to some recent significant write-offs, he notes.

Trimark Resources continues to have significant holdings in two smaller-cap gold producers: Torex Resources Inc. TXG and Detour Gold Corp. DGC.

Torex, says MacDonald, owns 100% of the Morelos gold project, an advanced-stage exploration property, located southwest of Mexico City. "It is one of the best underdeveloped gold resources globally." The company, he says, has a "healthy" balance sheet and has the financing in place to commence production. Furthermore, the ore is "high grade," which helps to keep production costs down.

Detour's flagship property is the Detour Lake Mine in northeastern Ontario. The company recently finished all the construction for this mine, he says. "It is a low-grade deposit, which could affect its cash operating costs." The stock, he adds, has declined significantly in the last year.

Detour Gold Corp. Torex Resources Inc.
April 22 close $11.04 $1.38
52-week high/low $29.07-9.80 $2.29-$1.19
Market cap $1.3 billion n/a
Total % return 1Y* -21.5% -23.8%
Total % return 3Y* 1.0% -5.5%
Total % return 5Y* 2.2% -7.3%
*As of April 22, 2013
Source: Morningstar

In the base-metals segment, MacDonald says he has been consistently adding to his holding in Turquoise Hill Resources Ltd. TRQ, an international mineral exploration and development company which was formerly known as Ivanhoe Mines Ltd.

Turquoise Hill's principal asset, says MacDonald, is its 66% interest in the Oyu Tolgoi project, one of the world's largest copper mines, in southern Mongolia. The Anglo-Australian mining giant Rio Tinto group has a controlling stake in Turquoise Hill.

In the forest-products segment, MacDonald sold his holding in Norbord Inc. NBD, an international producer of wood-based panels. "The stock had a huge run in 2012."

Turning to energy, MacDonald says that some 20% of the portfolio is in natural-gas producers and this segment of the sector is "doing well." A U.S. based "low-cost" natural-gas producer that he particularly likes is Ultra Petroleum Corp. UPL.

The company has substantial interests in the Pinedale and Jonah fields, significant natural-gas fields in Wyoming. It is in early development stage in the northeast United States, focusing on the Marcellus shale field in Pennsylvania. "The Marcellus basin is an extremely economical gas play," says MacDonald.

Of the oil producers in the portfolio, MacDonald highlights Whiting Petroleum Corp. WLL as a play on the prolific Bakken resource field in North Dakota.

Whiting controls one of the largest acreage positions in the Bakken play, he notes. Management of the company is "seasoned," he says, and the company could present itself as "an attractive takeover candidate."

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Sonita Horvitch

Sonita Horvitch