Gold Stocks (GDX) Slide, Remain “Very Inexpensive”

GOLD STOCKS NEWS – Gold stocks slid Wednesday morning, with the Market Vectors Gold Miners ETF (GDX) falling $1.16, or 1.8%, to $62.23 per share.  The sell-off in gold stocks and the GDX was fueled by a modest move lower in the price of gold, which dipped $11.40, or 0.6%, to $1,822.30 per ounce amid strength in the U.S. dollar.  Canada’s leading gold stocks composite, the S&P/TSX Global Gold Index, dropped 1.2% to 428.09 alongside the GDX.

Since reaching a new all-time record high of $66.98 per share last Friday, the GDX has now fallen 5.6%.  On a year-to-date basis, the gold stocks ETF has climbed just 2.6%, which trails the yellow metal’s 28.2% rise in 2011 by a wide margin.

The GDX is comprised of many of the world’s largest gold stocks – the majority of which have underperformed the yellow metal by a great deal in recent years.  One of the foremost examples of this has been Newmont Mining (NEM), the largest-U.S. based gold producer, the only gold stock included in the S&P 500, and the GDX’s third largest component after Barrick Gold (ABX) and Goldcorp (GG).

Although NEM hit a new all-time high of $66.61 last Friday, it is currently higher by only 4.8% year-to-date.  Last year the company became the first and only company in the sector to offer investors a dividend linked to the price of gold – which was viewed by many analysts as a way for the company to provide enhanced gold price leverage and win back the good graces of investors.

Yesterday, Newmont Mining’s CEO Richard O’Brien told CNBC in an interview at the World Economic Forum in Dalian, China that the company may also consider a share buyback program to reduce “this disparity between rising gold prices and equities trailing.”

In addition, CNBC noted that “Despite some analysts warning that gold prices are in a bubble, O’Brien says the company has no plans to hedge its production or to substantially increase its exposure to copper, a step taken by rival Barrick Gold when it bought Equinox of Canada.”

At the Forum, O’Brien also predicted that the gold price may reach $2,500 per ounce by 2013.  ”I don’t see the facts to cause the gold market to change in at least five years,” he contended.  ”There’s going to be a lot of volatility, up, but volatile…We are going to continue to see the support for gold in that $1,850 range and above.”

Newmont was also in the news this week after J.P.Morgan analyst John Bridges highlighted it as one of his top picks in the gold stocks sector.  In the firm’s report, Bridges wrote that:

Currently the disconnect between gold equities and the gold price is extreme and, as we enter gold’s seasonally strong fall season, it’s reasonable to expect some recovery. However, we note the gold price is itself extreme, reaching three standard deviations above its mean. While gold equity valuations anticipated rising prices over the last 20 years, they now seem to be pointing to gold prices below current spot levels around $1,200oz. JPM’s Colin Fenton argues for prices as high as $2,500 on market volatility and a weaker dollar. Although, as the price of Club Med country Sovereign debt rises, it’s possible that the US dollar could strengthen further if investors get tired of waiting for solutions to Europe’s problems.

The wave of cash flow for gold miners may challenge mine managements. At $1,900/oz the North American gold miners are trading on record-low FV/EBITDAs of 6.3x. For those that value gold equities off the forward curve, this implies the gold equities are very inexpensive, since they imply a gold price of just $1,200/oz. We feel that the long-term gold price needs to be at least $1,200/oz and taking inflation into account probably closer to $1,300/oz. Interestingly, it was only after gold prices established themselves above $1,200/oz that the miners were able to begin replacing reserves and (including new projects) deliver growth.

In light of this commentary, J.P.Morgan reiterated its Overweight rating on NEM, as well as on Barrick Gold, Goldcorp, Jaguar Mining (JAG), and Kinross Gold (KGC).  Below are the firm’s target prices for each gold stock, as well as the implied premium over the current share price:

NEM – $84.00, 32.0%

ABX – $55.00, 4.4%

GG – $66.00, 29.0%

JAG – $7.00, 12.0%

KGC – $23.00, 35.5%