Wednesday, June 17, 2009

NCM - Newcrest as a proxy for the inflation/deflation quibble

The long road to recovery will be paved with gold - or so some of the recent media commentary would suggest.  What is this all about?  And more importantly, can I take my pick and shovel to the road and get me some of that yella stuff?

In short, I'm in the camp that sees gold tracking higher over time and my favourite proxy for playing this view is Newcrest (NCM).

What's it all about?
One of the key questions being debated by all and sundry is whether we are going to be living in a deflationary or inflationary environment.  The arguments for and against are plentiful and, depending on who you are listening to, can be equally convincing.  For what its worth, I'm inclined to see inflation kick in over time - as governments are going to be loath to have a re-run of the 1937 double dip or the similar experience in Japan as it tried to claw its way out of recession.  For this reason I reckon they will leave their foot on the accelerator notwithstanding the flashing blue light and ever so polite bobby suggesting they pull over.

But for the moment its anyone's guess.  As a result we are likely to continue to witness sharp swings in commodity prices and the USD - but in my assumptive view, within a trend to higher commodities (including gold - though I don't know whether it's a commodity or some form of money) and a lower USD overall.

So to my proxy for this debate...Newcrest
To my mind its the premium gold stock in the country.  They have cleaned up their balance sheet (gearing ~1%!) and are running unhedged on the gold price.  They have a rich inventory of low cost mines (current production at around US$350/oz versus a world average of US$467/oz) and a capable management team.

How to value them?  To be fair, I've never really understood why these stocks trade at the prices they do.  They consistently trade at premiums to industrial companies that have superior earnings growth profiles.  And when I say 'they', it's because its a global phenomenon.  Have a look at some presentations from management (this one and page 9 of this one) gotta say according to these measures Newcrest stacks up as relative 'value'.

On the negative side, NCM is being hit by a rising AUDUSD, which partially negates the rising margins they enjoy from higher gold prices.  (How does this work - Newcrest sells its gold in USD - so it is principally a USD based company - but a fair swag of its operating costs are priced in AUD (labour, head office etc).  It's debt is priced in USD.  You get the drift.)

I think the point here is that gold companies should be viewed as 'trading' positions rather than 'investments' - given I don't understand the 'value proposition'.  Maybe its a meaningless distinction, but to me this helps define the expected holding period and triggers for entry and exit.  In a sense, I hope to trade the volatility in the stock.

So how to assess NCM from a trading perspective?  
Consider the following chart of NCM.

Viewed as a trading stock, the recent pullback in NCM makes a good deal of sense.  The fervour in the media of late is reminiscent of an overly bullish sentiment.  Commentators have been pointing to the smart money piling into gold (look to the various hedge funds that have built up sizable stakes in the metal - MarketFolly tracks various leading hedge funds and has been noting this trend among the Tiger Cubs etc).  In a trading view this hype virtually guarantees a move lower to take out all those suckered in at the recent top.  Note that the recent price action in NCM has been very similar to gold stocks/funds globally (eg. have a look at Newmont and the SPDR Gold Shares ETF).

The question then becomes how far must it fall before these weaker hands are stopped out.  In my experience generally further than you would expect.  Note, for example, the break of the short term trend line.  This is what you would expect if you subscribe to the theory that there would be a pile of 'trading' stops sitting just beneath these levels hoping for the trendline to hold.

In summary I like this analysis from Minyanville, on where we sit with gold.  On this basis, it makes sense to dip the toe in the water around these prices in NCM.  But not large, not yet.

As I say, from a trading perspective these things have a habit of going further than you expect.  I'm sensitive to the arguments from the elliotitians that are looking for a deeper sell-off in gold to around $750.  This is not out of the realms of possibility, as I don't think that the governments around the world are going to throw in the towel on the USD.  We have seen this in the recent jawboning by China and Japan that has helped the USD recover some ground.  Also, G8 meetings have form for organising concerted actions to support the USD.  

In summary, I'm establishing a beachhead in NCM at today's price ($30.80) because I want to be long gold.  But its small.  I'll hope to load up on NCM around $25 - that's where long term support kicks in - and if we get there, the media will be starting to talk about how gold has become irrelevant etc...


  1. At the risk of monopolising the comments section of your blog, I thought I would make a quick comment on NCM, which is another stock I follow (and owned until a month or so ago).

    I think you're right about $25 being the price at which you want to be really getting stuck into NCM, but I think there could still be short-term good news. RBS came out with a report today which has NCM as one of their potential upside earnings surprise ideas, which I think may be correct. It's true that you cannot value NCM using any rational valuation technique (I guess theoretically it's really just a DCF stream of gold ounces extending out for the life of the mine, but that just doesn't begin to capture the market value).

    I think long term you do want to be long gold (put me in the long run inflationary camp), but the short to medium term may not be that rewarding. I try not to indulge in too much conspiracy theorising, but it is not in the interests of monetary officials (or govt officials for that matter) to have gold at US$1,500 per ounce or whatever. Of course that doesn't stop low-cost, well-run producers such as NCM from earning a good living from digging holes in the ground.

  2. Feel free to monopolise...from the research I've seen on blog use in Australia, it's still a new technology for the 35 to 60 year old bracket. It's going to change over the next 12 months...but in the meantime guess we can enjoy the wide open spaces.