Citi analysts Jon H Bergtheil, Johann Steyn, Heath R Jansen, Jatinder Goel, Michael E Flitton, Craig Irwin and Alexander Hacking provide a well-reasoned analysis of the gold market and their basis for downgrading Randgold Resources Ltd. (ADR) (NASDAQ:GOLD) (LON:RRS), Fresnillo Plc (LON:FRES) (OTCMKTS:FNLPF) and Polyus Gold International Ltd (LON:POLG).

Bearish on gold

Citi’s view is that gold topped out in 2011 and is yet to climb out of its bearish depths.

Furthermore, since the worst of the GFC is over and there is a global economic recovery afoot, the risk insurance component in gold value, estimated between USD 700-900/oz at the last high, could have vanished. This makes a case for a readjusted gold price of say USD 1100 – 1200/oz.

Temporary price boosters such as Syria are now out of the equation.

The taper non-event led to a rally in gold, but Citi makes the very significant point that “the rally ran into significant volumes of producers selling before the end of the day, suggesting gold producers themselves have little in the way of positive price expectations.”

As far as tapering is concerned, it is a question more of ‘when’ rather than ‘if’. Citi expect tapering only to have been kicked down the road (possibly to late December), and the slide in gold prices to resume thereafter.

Chinese demand may slow down given that the country may be already very well-stocked with gold (Citi are of the view that physical overflows from ETF selling have moved to China). Indian demand has already been tempered by the imposition of record high import duties.

All in all, gold prices are expected to plunge below $1250/oz before the year end.

Apprehensive on mining costs…and cash

Citi estimate that the industry is still behind in cutting costs, though progress has been made. According to estimates, at spot price levels, “most of the global gold cost curve is burning cash, and that further cuts are likely over the next 6-12 months as companies try to adjust to a lower gold price environment.”

Unfortunately that puts the miners between a rock and a hard place. That’s because recent trends show that larger amounts of capex are required to sustain production levels and to rein in costs on a per-unit level. Yet cash control is crucial given that gold prices have fallen 12%. To cut (capex) …or not to cut…that is the question…

gold-unit-cost-yearwise

Citi make the point that global gold capex has risen 10 times during the past 12-years but production has in fact declined 5%, leading to a rise in unit costs at a CAGR of 16%.

gold-costs

Distrustful on equity valuations

Citi make two key observations on why they are suspicious of gold equities valuations.

Citi juxtaposes gold shares against valuations obtained on diversified mining groups to ascertain whether gold shares offer value against those.

“Our favoured diversified miner is Rio Tinto plc (ADR) (NYSE:RIO) (RIO.L, Buy; TP £38.00) at the moment and we calculate that it is on a 24% discount to NPV. In contrast, we calculate that Fresnillo Plc (LON:FRES) (OTCMKTS:FNLPF) is on a 41% premium to NPV, Randgold Resources Ltd. (ADR) (NASDAQ:GOLD) (LON:RRS) is on a 36% premium and Polyus Gold International Ltd (LON:POLG) is on a 20% premium. We do not believe that those valuations are warranted under Citi’s assumption that we are still in a gold bear market.”

The second point Citi make is that gold stocks took a substantial haircut in valuations after the last major cyclical peak in 1979/80, but a similar correction is yet to be seen in gold stocks after the metal’s $1850/oz top.

“All that the gold and silver stocks have done in 2013 is to re-calibrate their share prices for the revenue and earnings change resulting from the fall in the gold price. They are still standing at substantial valuation premiums to the likes of RIO and BHP Billiton Limited (ADR) (NYSE:BHP) (BLT.L; Neutral; TP £20.70), and this is at odds with the way gold shares performed post-peak in 1980 and 1981.”

Current ratings

company-valuations