SA gold and platinum miners hurt by strong rand

The rand, an unusually strong currency, is set to inflict deep wounds on South African gold and platinum (among other) miners during the second quarter of 2009, argues RBCCM.

JOHANNESBURG - 

"We suspect the dramatically reduced forecasts will come as much as a surprise to the market as it did to us when we did this exercise", say Leon Esterhuizen, Yuen Low and Arnold van Graan, analysts at Royal Bank of Canada, following revisions to their gold and rand currency forecasts. On a variety of measures, the rand ranks as the world's best performing currency over the past 12 months, an event that hurts rand earnings of South African exporters, and stimulates rand-equivalent imports. 

The rand has strengthened from a level of around 11 to the dollar at the outset of 2008 to around eight currently. Seen against the traded weighted dollar, RBCCM analysts remark that while this may be interpreted as a simple "unwinding" of the credit-crunch blowout that was witnessed at the end of 2008, it could also be more ominous when viewed as a direct response to recent dollar weakness. The potential remains, argue the analysts, that the rand could even strengthen beyond the level of eight to the dollar, or when the dollar weakens further. 

While the short-term negative impact on South African gold companies is limited by the fact that RBCCM analysts have increased dollar gold price forecasts, the much stronger rand-dollar exchange rate forecast (from over 13 to the dollar to only 10 long-term) is found to have a "significant negative impact on the long-term earnings and NAVs (net assets values)". 

Thus the analysts find a roughly 25% reduction in earnings expectations for the major gold companies over the next 12 months, while NAVs decline, on average, by some 35%. In an effort to reduce volatility in forecasts, RBCCM analysts have opted to move away from using the forward curve in their currency forecasts, applying instead a long term flat rate of 10 rand to the dollar. 

The inflicting of wounds is confirmed by RBCCM analysts when the expected quarter-on-quarter impacts on earnings for the second quarter of calendar 2009 are studied, assuming the current rate of about eight to the dollar, and a gold price of USD 980/oz remaining in place for the remainder of June. 

The impact indicates, for RBCCM analysts, rough estimates of the potential for a ±80% negative quarter-on-quarter (relative to the first quarter of 2009) impact on earnings potential for the major gold producers. From these rough estimates, AngloGold Ashanti could deliver a 78% quarter-on-quarter drop in earnings; Gold Fields  could deliver a drop of some 77%; Harmony could see earnings down 87%, and DRDGold could well deliver a small loss from what was record cash earnings in the previous quarter - a 138% swing. 

The analysts reiterate their view that despite some strong recent moves for gold bullion, "we are now entering a seasonally weak period for gold (June-August). The summer low for gold in the past two years was in mid-August. In our view, these ‘summer doldrums' are related to a period of weak physical demand, coupled with low trading volumes over the summer months". 

However, this summer, RBCCM's analysts have additional concerns beyond the seasonally weak period ahead, "including the current high levels of speculative interest in gold, and the strong ETF [exchange traded fund] demand seen earlier this year (we are not convinced all the additional ETF demand represented longer-term investors). While we still see risk for a summer pullback in gold from current levels, we remain bullish overall, expecting gold to re-gain current levels later this year, and re-test previous highs over the next year or so". 

The general sentiment from RBCCM over South African gold stocks applies more generally across the domestic resources space. The RBCCM analysts find that despite a rand-driven "significant reduction in profitability in the current quarter", investors prefer to "completely ignore this in the face of a rising PGM [platinum group metal] basket price in USD-terms". 

"Still, the risks are obviously now increasing into the realm of speculative investment because current metal prices in rand-terms do not support the current share valuations (PGM and gold shares). All we can do in a situation like this is to indicate the fundamental valuation ‘gap' (as a proxy for the implied downside risk if the metal price does not increase to levels implied by current market valuation) and to illustrate the ‘least at risk' shares as preferred vehicles for investors willing to accept this risk". 

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