The price of gold fell to $1,080 an ounce today, the lowest level in more than five years. Prices have steadily fallen from its 2011 highs of almost $1,900 an ounce, as the prospects of rising interest rates in the US has strengthened the US dollar, curbing investor appeal for the metal.
With gold traditionally seen as a safe asset, gold prices tends to rise during periods of market uncertainty. However, this correlation seems to be breaking down in recent years. Unlike in earlier crises, the recent Greek crisis not little effect in pushing gold prices higher. It is difficult to predict how long this phenomenon will last, but it probably won’t last forever.
Buying gold is also seen as defence against rising inflation. But in recent months, fears of a rapid growth in inflation has subsided, as inflation remains stubbornly low in developed economies. In addition, the Federal Reserve and the Bank of England have indicated that they will raise interest rates soon.
Because of the historical link between fear (or risk aversion) and gold, listed gold mining companies are often seen as defensive stocks.
Shares in Randgold Resources (LSE: RRS) have a five-year beta of 0.73. Beta is a measure of how responsive a particular share is to wider movements in the stock market index. Shares with a beta of less than 1 tend to move less strongly with changes in the market index.
Randgold benefits from a strong balance sheet and a long-term track record of delivering steady production growth. But with a forward P/E of 23.0, its valuation is very expensive. With the falling gold price, further downside revisions to analysts’ estimates of earnings is likely. And, absent from further declines in its share price, this will push its forward P/E even higher.
Fresnillo (LSE: FRES), the Mexico-focused gold and silver miner, delivered a strong set or production figures for the first half of 2015. Gold production rose 37.0% to 364 thousand ounces, whilst silver production rose 10.6 to 23.8 million ounces. Analysts expect underlying EPS will rise by 171% to 12.9 pence this year, but that still leaves it with a forward P/E of 47.1.
Smaller gold miners, including Centamin (LSE: CEY) and Petropavlovsk (LSE: POG), are less attractive as defensive stocks. Centamin, which focuses on the ramping up production from its Sukari mine in Egypt, faces far greater execution risks than more mature miners. Centamin’s average production costs per ounce of gold is also much higher than many of its peers.
Petropavlovsk, on the other hand, has a relatively high level of indebtedness. But, recently the company has shown strong progress in improving efficiency, and it expects its cash production costs will fall from $700 per ounce in 2014 to around $600 per ounce in 2015. Although not a defensive stock, Petropavlovsk’s forward P/E of 5.4 makes it an attractive turnaround stock.
The defensive nature of gold mining stocks makes them worthwhile additions to anyone’s portfolio. It’s just a matter of picking the right moment to buy them. With gold prices free-falling, now is probably not the best time to buy into gold mining shares.
