By Andrew Main

Gold share investors aren’t in the mood to cope with bad news, judged by the shellacking that followed the downgrade issued by Perth based west African operator Perseus Mining.

In case you missed it, the price of gold in US dollars has dropped by around 16 per cent since September, despite Donald Trump’s shock election to the US presidency and the associated risks.

 

It’s now around $US1,135 an ounce compared with $US1,350 just over three months ago.

So when Perseus told the market last Thursday that things at their operations in Ghana were not going as well as had been previously advised, the shares ended up being whacked down from by more than a third from 53 cents to 34.5 cents, since when they have done the expired feline experiment back up to 35 cents. These are shares that back in early November were worth more than 67 cents each.

 

 

The news was the sort of thing that gold miners have to fess up to regularly. A longer than expected maintenance shutdown of the mill in October at the company’s Edikan mine and a lower than expected head grade caused the estimate of gold production for the current half to drop from around 90,000 ounces to a figure more like 75,000 ounces.

And with that, the estimation of the All In Site Cost (AISC) of gold production for the period “is now expected to be between $US1,550 and $US1,650 per ounce” as management put it.

Three months ago that number would have been a bit worrying, being $US250 below the AISC, but that gap has now yawned out to more than $US450 an ounce. Ouch.

Management’s done a fair job of hedging, with 176,880 ounces sold forward at $US1,280 an ounce, but it’s still firmly underwater. To be fair, All In Site Costs include production costs, plus royalties, plus all sustaining and development capital costs, but the current picture isn’t pretty.

Looking to the future

They’re much more positive about the coming June 2017 half with expected output of around 135,000 ounces, but that’s in the future and past predictions have now been shown to have been too optimistic.

Where gold miners usually maintain investor morale is via the “jam tomorrow” descriptions of promising nearby exploration areas. They’ve got two other west African exploration projects, Sissingué and Yaouré, near neighbours to each other in the adjoining state of Ivory Coast, but Perseus has just had to announce a 20 per cent downgrade to the resource estimate for Sissingué, which they hoped to have up and producing by late 2017 and which will now not start until the end of February 2018.

The problem was sheeted home to contaminated drill samples rather than excess optimism, but this is a company which told a Denver conference in September that the total AISC would drop to below $US1,000 an ounce in the 2017-18 year and that the average AISC over a projected 7.5 year remaining life would be around $US865.

That’s lots of short term gloom but there are a number of issues in play here. One, Perseus is one of the most highly leveraged gold miners listed in Australia.

That’s great news when the gold price goes up, because profits lift at a greater rate than their peers’ do, but of course the reverse works when the bullion price goes down.

Gold loses its shine when other interest paying asset classes become more attractive, as has happened in the US and elsewhere because President elect Donald Trump has said he wants to rebuild infrastructure in the US.

That’s despite the fact that gold historically rises on the threat of inflation, which occurs when governments need to borrow big licks of money…to rebuild infrastructure!

Perhaps there’s another shoe still to drop here, although many experts say the risk of serious inflation remains very modest. Whatever happens, the gold price won’t keep going down for much longer.

The ET-eFfect

And there’s another factor at work on all the smaller gold producers that a lot of people haven’t thought about: the impact on prices of Exchange Traded Funds or ETFs.

On Friday there were 100 million shares in Perseus that went through the ASX, way more than on Thursday, the day of the downgrade announcement.

We can’t be sure just how much of a stock like Perseus is owned by ETFs, but the problem is that if a big issuer, such as US based VanEck, gets hit by redemptions (as has happened across the board in recent weeks) it is compelled to sell shares to keep its holdings in line with the relevant index weightings.

Such issuers are called value agnostic in that they can’t play games with adjusting weightings, as that would be outside their mandate.

A recent report by RBC Capital Markets noted that VanEck alone holds around 18 per cent of Regis Resources, 16.53 per cent of Saracen Minerals and 14.68 per cent of Resolute.

There’s nothing villainous in VanEck’s ETFs alone holding an estimated 7 per cent of the Australian gold sector but the effect can be a lot like a highly leveraged stock such as Perseus.

As the RBC report puts it, “while funds flow in, active investors are competing against passive buying requirements, driving prices higher.

“On the downside there can often be a lack of support as investors flee the space while mandatory selling continues unchecked from what are essentially value agnostic investment products.’’

The bank concludes this actually provides buying opportunities at the bottom, “where valuation and share price can disconnect as redemptions lead to continued selling pressure below fair value, obscuring the conventional price discovery process.’’

Back on their models, the analysts certainly aren’t excited about Perseus, even at these levels.

Citi’s moved it from Neutral to Neutral/High Risk, pinning a very modest 12-month target of 42 cents on the stock, while UBS is a mite kinder with a straight Neutral recommendation and a target of 60 cents. However FNArena’s consensus estimate across a wider broker sample is for a target of 71 cents.

The bottom line

Given all that, Perseus has to be one for the brave at the moment, unless you believe the gold price is going to snap back upwards any time soon. Leverage, in this circumstance, is everything.

 

Andrew Main is a shareholder in Perseus Mining.