Stick With Gold Shares

Gold still has upside, and gold shares could soon play “catch up”.

Stick With Gold Shares

O ur Commodity &  Energy Strategy believes that it is too soon to give up on gold and the same is true for gold shares. Gold miner profits track gold prices and this has not changed in the past few years, although the tracking is far from perfect. What has changed is the traditional 2:1 relationship between changes in gold shares and underlying prices. Global gold shares are flat year-on-year in dollar terms, yet the dollar price of gold is up 22%. This is despite the fact that gold company hedge books are leaner than they have been in years.

One possible explanation is that commodity-sensitive currencies have been strong in recent years. This places a wedge between revenues and costs for many gold producers. Put another way, gold in C$, A$ and SA rand terms has been weaker than in U.S. dollar terms. However, that has not been the case in recent months as the commodity currencies have dropped in the face of investor risk aversion.

A more likely explanation relates to the ETF phenomenon.

Gold company multiple compression accelerated as ETF holdings hit successive new highs in 2010 and 2011. While the divergence is unsustainable, it is difficult to tell when it will end. Even if gold shares are in a bear market versus gold prices, they are stretched relative to the downtrend in place since 2006. P

erhaps global reflation and a softer dollar will spur a “broadening” of interest in lagging liquidity plays, such as gold shares.

Bottom line: Continue to hold strategic positions in gold and gold shares.

Eurozone Growth Remains Weak In Q3

The euro area managed to eke out a 0.2% growth rate in Q3, matching the previous quarter

T he solid growth in Germany and France (at 0.5% and 0.4%, QoQ respectively) seems to be the only remaining driver of the struggling euro area economy, according to Eurostat’s flash figures for Q3 GDP growth. Growth in Spain came to a standstill, while the Portuguese economy continued to contract. Going forward, the downward trending confidence indicators and PMIs suggest that the entire euro area is headed towards a recession. Also, additional fiscal drag and the prospect of raising bank solvency ratios by shrinking assets will not bode well for the European economy.

A worrying implication of the lack of growth is that the periphery countries will find it harder to reach their deficit targets by implementing austerity programs. This possibility of worsening debt dynamics will make markets even more wary about the current efforts to deal with the European crisis. Indeed, widening French, Italian and Spanish spreads already highlight the dangers of indecisive action and political turbulence.

Bottom line: The looming recession makes it ever more pressing for euro area policymakers to bolster their efforts, but also limits their ability to rely on fiscal belt-tightening to restore confidence. We maintain that growth oriented policy changes and more aggressive action by the ECB are required to resolve Europe’s crisis.