Energy / Resources

As the share prices of many mining services companies performed as we have been warning they would, the question we receive from many investors is: is time to wade back in? In the context of Mermaid Marine, we address the question.

Value investors will need great skill to make money from the resource services sector. Pessimists point to $150 billion of mining and energy projects delayed, cancelled or reassessed in Australia in the past 12 months. Optimists argue that there is value aplenty in the sector after horrific share price falls.

The truth is somewhere in between. There is good reason to continuing avoiding the resource-services sector: the Bureau of Resources and Energy Economics (BREE) forecasts the worth of committed projects, or those likely to get to that stage in the next five years, will drop from $256 billion from the end of 2013 to about $70 billion in 2017.

It could get worse if falling commodity projects force a few mega projects to remain in publicly announced feasibility phases, meaning even less work for service providers. Boart Longyear’s terrible earnings result in August and talk that it could breach debt covenants reinforces the danger. Don’t be surprised if a few lower- quality mining services companies go under in the next year or two.

Resource services is not a great industry at the best of times: it is highly leveraged to projects that rely on volatile commodity prices, requires high fixed investment, suffers from rapidly depreciating equipment, and is a price taker. Shrinking profit margins are another huge risk this financial year.

But if all of that doesn’t dissuade you, the question is whether this deteriorating outlook is already priced into valuations. Monadelphous Group, for example, appears to be back in value territory, but it needs to offer a bigger margin of safety, such is

the uncertainty about resource projects. Forge Group and Decmil Group might also be considered similarly.

Then there are resource service providers rising in a falling sector. The well-run Clough group has doubled to $1.44 since late 2012 after earnings upgrades. Accommodation provider Titan Energy Service has soared fivefold in the past 12 months on the back of higher earnings, and Mermaid Marine Australia, which provides vessels for oil and gas projects, has rallied in the past year.

That shows the danger of being deafened by newspaper headlines and market noise about falling mining investments and extrapolating it to all stocks, rather than treating each company on its merits. Value investors should always focus on what matters most: buying exceptional companies at bargain prices. On this score, Mermaid Marine warrants a spot on watchlists.

A 10 per cent share fall would arguably put Mermaid within sight of value territory; and a cheaper entry point could emerge as the sharemarket moves into the traditionally weaker September and October months, and as nervousness about emerging markets and US Federal Reserve plans to ‘taper’ its stimulus program creates higher market volatility. Whatever happens, Mermaid might be worth watching.

Like Clough, Mermaid is heavily exposed to the energy sector. It provides marine logistics to offshore oil and gas projects and has supply bases in Dampier and Broome. The core operation comprises a fleet of more than 30 ships; the Dampier base has a private wharf and ship-repair facility; and the Broome supply operation is a 50/50 joint venture with Toll Holdings.

Choosing service providers with a bias towards higher-margin oil and gas projects rather than mineral developments is a smart move. Committed liquid natural gas and petroleum projects were worth more than $200 billion at April 2013, according to BREE. That dwarfs all other products (by commodity) and there are still several big energy projects in publicly announced feasibility stages.

The energy boom has been a huge tailwind for Mermaid. Over five years, the company has an average annual compound return (including dividend reinvestment) of 21 per cent. Over one year to August 30, it has returned 26 per cent – a good result in such a weak sector.

The latest profit result impressed, given cyclone-affected vessel utilisation rates in the third quarter. Revenue rose 18 per cent to $449.5 million and after-tax net profit lifted 18 per cent to $60.3 million for 2012-13. Earnings per share rose 15 per cent to

26.9 cents and a 12.5 cent full-year dividend was declared.

A flat result in the vessels division (63 per cent of revenue) was offset by strong results in the supply base and slipway (maintenance) divisions.

Another concern is the strength of Mermaid’s sustainable competitive advantage. Being the dominant vessel provider in Australia, and having an integrated offering of vessels, supply bases and maintenance gives it a significant competitive advantage over smaller rivals. It also has an excellent industry reputation.

However, this advantage is arguably hard to scale overseas and this is relevant given the company has signalled international expansion as a key strategic priority. Different union arrangements and regulatory regimes in other countries may limit growth, and currently only 2.9 per cent of Mermaid’s revenue comes from its offshore operations.

Mermaid is heavily exposed to a small number of energy projects in Australia that will start to wind down in the next few years. It still has solid, long-term earnings prospects, given these projects will require plenty of ongoing vessel and supply-base support, but growth could plateau.

Mermaid ticks plenty of boxes for value investors. Return on equity (ROE) has hovered around 17 per cent in the past seven financial years and peaked at 21 per cent in FY10. Although solid rather than spectacular, Mermaid’s ROE consistency is notable in a volatile sector.

Cash flow generated from operations has soared from $18.1 million in FY07 to $70.8 million in FY13. Gearing (net debt/equity) of 30 per cent at the end of FY13 was hardly excessive given Mermaid has invested more than $200 million in fleet renewal and infrastructure development programs over five years. And it has $58.8 million in the bank.

Mermaid said its medium-term outlook “remains strong”, with construction on mega energy projects such as Gorgon ($52 billion) continuing through FY14 and FY15, near-shore works underway for Wheatstone ($29 billion), and several other project tenders yet to be awarded or called for.

The company announced in August it had won a $100 million contract to provide tug and barge support for part of the Chevron- operated Gorgon project – an encouraging result given the risk of lower fleet-utilisation rates as construction activity at Gorgon trends lower in the next few years.

Earnings from supply bases, just over half of Mermaid’s FY13 earnings before interest and tax, look more vulnerable as energy construction slows in the next few years. This might explain why management is increasing the company’s exposure to production- support contacts and new project activity here and overseas.

Mermaid should have decent earnings momentum in FY14 and FY15, but the big question is: what happens when investment in giant energy projects tapers after that? Here at Montgomery, we don’t treat that question lightly: will Mermaid be left with a huge earnings void that is hard to replace? And when will the market price this in? New enterprise bargaining agreements and potential for rising industrial disputation are other threats.

According to its valuations, Montgomery expects Mermaid’s ROE to ease from 16 per cent in FY13 to 15 per cent over the next two years and 14 per cent in FY16, based on consensus analyst forecasts. Value investors should seek companies with rising, or at least stable, ROE, and at least above 15 per cent, for it usually leads to higher intrinsic value and ultimately a higher share price.

At $3.77, Mermaid remains overvalued. Value investors should look for companies that can deliver strong increases in intrinsic value in future years. Given the uncertainty surrounding 2015 and beyond, the jury remains out on the score for Mermaid.

Investors should also demand a higher margin of safety from resource-service stocks, given uncertainty about the project pipeline and rising earnings risks. Mermaid might need to trade closer to $3.00 to tempt long-term value investors.

Although not exceptional, Mermaid has been of high quality for a long time and after share price gains this year is only modestly overvalued.

This article was written on 1 Septemeber 2013. All share and other prices and movements in prices are to this date.

by Roger Montgomery Posted in Energy / Resources.

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Those of you who are boat owners would know all about the V-Sheet – distress signal. A ‘V’ is also one of the shapes a recovery can take. But while the ‘V sheet’ is an apt alphabetical metaphor for the state that mining services is now confirmed to be in, it isn’t the right shape anyone should be expecting recovery to take. continue…

by Roger Montgomery Posted in Energy / Resources, Insightful Insights.

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REPORTING SEASON SPECIAL EDITION: In this bonus white paper, exclusively for rogermontgomery.com subscribers, find out what Montgomery’s view on Monadelphous’s intrinsic value is and why the former market darling Monadelphous is lacking in mojo. continue…

by Roger Montgomery Posted in Energy / Resources, Whitepapers.

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Following a heavy share price drop earlier this year, Monadelphous Group may look like a bargain to some investors. In this article, Roger Montgomery discusses our view on the former market darling.

Successful value investors have a clear focus: buy exceptional companies at bargain prices. Mining services provider Monadelphous Group (ASX:MND) has performed exceptionally for nearly a decade, and after slumping 40 per cent this year on fears of a fading resources boom it may look like a bargain.

The market doesn’t see it that way. Broking firms have fallen over themselves this year to issue sell recommendations on MND and short sellers and even some prominent offshore investment newsletters have gone cold on the former market darling. Its share price has tanked, falling from over $27 to under $15 recently.

In turn, competition among mining service firms has intensified and led to greater price discounting and lower profit margins. At the same time, big mining companies have renewed focus on cost cutting to help counter falling revenue, meaning further pressure on service providers.

The result is poor earnings visibility for most mining services stocks. Service providers, of course, point to their pipeline of work to reassure the market. But the pipeline can dry up quickly for companies at the mercy of projects being deferred or cut back.

Seasoned value investors know the best time to buy is when everyone is selling and excessive market noise is driving stocks well below their intrinsic value. Such scenarios can create tremendous value opportunities for investors who go against the tide.

Could there even be parallels between higher-quality retail stocks and the best mining services stocks after recent price falls? Retail stocks were thumped last year amid market fears over a slowing economy and the threat of online retail sales. Six months later, the best retailers, such as JB Hi-Fi and The Reject Shop (both owned by Montgomery Funds), had soared off their lows.

Nothing had changed fundamentally for retail – if anything, the outlook has deteriorated in recent months as consumer and business confidence has waned and retail sales growth slowed. The market simply over-reacted and oversold retailers, creating opportunities for value investors like Montgomery.

True believers could argue the same situation is unfolding for MND. Not unlike JB Hi-Fi in some ways, MND is its sector’s highest-quality company, firmly in the sights of short-sellers and bearish broking analysts, and battling a perfect storm for its industry.

The mining services sector has been a sea of profit downgrades and smashed share prices this year. Mining activity has slowed sharply because falling commodity prices have forced billions of dollars of projects to be cancelled, deferred or cut back. More cancellations seem inevitable.

At the full year MND reported an ‘abnormal’ period of growth. Full year 2013 profits grew to $156.31 million from $137.34 million previously. After tax profit rose 25 per cent on the back of a 37.8 per cent rise in revenue to to $2.61 billion. The engineering construction division (booking $700 million in, mostly, new iron ore contracts) reported a 56 per cent rise in revenue, and 50 per cent growth was recorded in infrastructure division revenues. Maintenance and industrial services however remained flat.

Importantly, the company noted that operating cash flow was being detrimentally impacted by mining customers lengthening contracts and increasing their payment terms. Chairman John Rubino wrote in his Shareholder letter, “Customer sentiment has changed from an aggressive growth focus to an efficiency focus as commodity prices have normalised in a rising cost environment”, adding, “with market conditions softening…2013/14 will be a year of consolidation

with revenue levels moderating and not expected to reach those achieved in the previous year.”

This is no market for companies with even a sniff of earnings uncertainty. Fund managers have shown they will pay higher multiples for large and even small-cap companies with “annuity style” recurring earnings, and dependable growth, such as telcos, utilities and banks – and punish the rest.

The big problem is nobody knows where the resource sector malaise will end. Trying to second-guess China’s economic strength and short-term commodity price movements is a mug’s game. The best guide is history: the commodity price cycle has a habit of doing better than the market expects on the way up, and worse on the way down – and it always takes longer to play out than investors expect – or should we say ‘longer than investors forget’?

Another certainty is the resource sector being a big ship to turn. Key headwinds for the sector, notably high wages and input costs, are starting to ease as lower demand pushes down prices. The resolution of the federal election on September 7 will help

if the Coalition is elected and reduces green tape and other regulatory and taxation uncertainty (carbon) for miners. And the lower Australian dollar is helping offset falls in US-dollar-priced commodities for local miners and ease some pain.

But these trends will take time to help resource projects. Perhaps in a few years the smart money might recognise the seeds have been planted for the next boom in resource stocks. For now, we believe a slow, painful transition is ahead as the resource sector deals with its own “new normal”.

The other problem is the nature of many mining services providers: high capital investment, high fixed costs, and rapidly depreciating equipment that can sit idle for months. This is a great industry when demand is strong but the sector historically only covers

its cost of capital under boom conditions. It is a terrible sector when projects quickly stop and one must remember that service providers have little flexibility.

MND’s result was strong but such growth cannot be repeated in coming years as the resources investment boom tapers.

As the market obsesses about next year’s earnings, it is worth examining MND’s strategy during this transition period for the resources sector. With revenue slowing, it wants to recruit more of the best talent, improve efficiencies, cut costs and diversify the business into other sectors.

Newspaper reports in August suggested MND might invest in the troubled telecommunications contractor, Service Stream, but MND did not respond to the rumour. It clearly has the balance sheet power to buy weakened competitors and move into other sectors.

Essentially, MND is de-risking the business and positioning it to cope with continuing profit-margin pressure and client demands for more service efficiency. It is a smart strategy, although critics could argue the transition should have happened earlier and that it adds to investment risks.

From a sentiment point of view, strategic shifts that create efficiencies and diversify earnings are not nearly as sexy as big contract wins and can quickly bore an impatient market. But they can also lay the groundwork for the next growth spurt, and reward long term investors who can withstand short term share price pain and volatility.

Overall, the macro outlook for MND and other service provides suggests more profit downgrades and disappointments (as we have been warned about by Boart Longyear), a pick-up in mergers, and even a few companies going into in administration in FY14. It is a brave speculator (rather than investor) who believes mining services stocks cannot possibly fall any further, after savage declines this year.

Value investors must consider whether MND can navigate through these conditions and come out stronger as it uses its balance sheet strength to diversify operations, and mop up weakened competitors. If it can, today’s valuation will look, with the benefit of hindsight, like a rare opportunity.

MND’s record gives hope. The market, of course, always looks forward, but in times of great earning uncertainty it can pay to look backwards as well. Monadelphous’s return on equity, above 50 per cent for the past seven reporting periods, is exceptional.

Its management team is among the best-regarded in the mining services sector, debt is low for a company of its size, and it has a history of under-promising and over-delivering. It has all the hall marks of a Montgomery-qualified business.

The $1.5-billion service provider, involved in large engineering construction projects, maintenance and industrial services, and infrastructure, earns a big chunk of its revenue from blue-chip clients such as BHP Billiton and Rio Tinto. In this market, look for mining services companies that are leveraged to production rather than exploration projects, and to lowest-cost miners that will survive if commodity prices fall further.

The critical question, of course, is whether MND’s valuation fairly reflects these opportunities and threats. Importantly, investors also need to be satisfied that the prospects for intrinsic value appreciation are bright. Speaking with the benefit of some experience, there is a risk of further declines to estimated intrinsic values if the industry doesn’t consolidate dramatically by attrition and price competition becomes irrational.

While MND might be trading at a discount to current estimates of intrinsic value, it is only significantly underpriced if one believes valuations may stabilise from here or rise.

According to consensus forecasts, MND will have to endure falling return on equity over the next two years. Investors should always look for companies heading the other way, with big future increases in ROE and intrinsic value.

MND should have a pole position on watchlists for investors who are comfortable with higher-risk sectors, such as mining services. It is not quite value, assuming a high margin of safety is required, but further falls could be a catalyst for more aggressive fund managers to accumulate the stock.

Importantly, we believe there is time for more conservative value investors to assess the situation. The resource sector’s transition will take a few years to play out, and MND itself could have a year or two of consolidation, before (if) stronger growth resumes.

by Roger Montgomery Posted in Energy / Resources.

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Following on from Ben’s post last week on Boom Logistics Limited (BOL), three other mining services sector-related businesses have also reported so far. continue…

by Russell Muldoon Posted in Energy / Resources, Insightful Insights.

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The crane industry in Australia is fragmented and highly exposed to capital-intensive projects in the mining and construction sectors. As such, crane operators do not generate sustainable competitive advantages that will protect earnings during an industry downturn. At Montgomery Investment Management, we have been very vocal about the risks inherent with investment in the mining services sector, and the latest full year result from Boom Logistics has justified this concern. continue…

by Ben MacNevin Posted in Energy / Resources.

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Following a heavy share price drop earlier this year, Monadelphous Group may look like a bargain to some investors. In this article, Roger Montgomery discusses our view on the former market darling.

Successful value investors have a clear focus: buy exceptional companies at bargain prices. Mining services provider Monadelphous Group (ASX:MND) has performed exceptionally for nearly a decade, and after slumping 40 per cent this year on fears of a fading resources boom it may look like a bargain.

The market doesn’t see it that way. Broking firms have fallen over themselves this year to issue sell recommendations on MND and short sellers and even some prominent offshore investment newsletters have gone cold on the former market darling. Its share price has tanked, falling from over $27 to under $15 recently.

In turn, competition among mining service firms has intensified and led to greater price discounting and lower profit margins. At the same time, big mining companies have renewed focus on cost cutting to help counter falling revenue, meaning further pressure on service providers.

The result is poor earnings visibility for most mining services stocks. Service providers, of course, point to their pipeline of work to reassure the market. But the pipeline can dry up quickly for companies at the mercy of projects being deferred or cut back.

Seasoned value investors know the best time to buy is when everyone is selling and excessive market noise is driving stocks well below their intrinsic value. Such scenarios can create tremendous value opportunities for investors who go against the tide.

Could there even be parallels between higher-quality retail stocks and the best mining services stocks after recent price falls? Retail stocks were thumped last year amid market fears over a slowing economy and the threat of online retail sales. Six months later, the best retailers, such as JB Hi-Fi and The Reject Shop (both owned by Montgomery Funds), had soared off their lows.

Nothing had changed fundamentally for retail – if anything, the outlook has deteriorated in recent months as consumer and business confidence has waned and retail sales growth slowed. The market simply over-reacted and oversold retailers, creating opportunities for value investors like Montgomery.

True believers could argue the same situation is unfolding for MND. Not unlike JB Hi-Fi in some ways, MND is its sector’s highest-quality company, firmly in the sights of short-sellers and bearish broking analysts, and battling a perfect storm for its industry.

The mining services sector has been a sea of profit downgrades and smashed share prices this year. Mining activity has slowed sharply because falling commodity prices have forced billions of dollars of projects to be cancelled, deferred or cut back. More cancellations seem inevitable.

At the full year MND reported an ‘abnormal’ period of growth. Full year 2013 profits grew to $156.31 million from $137.34 million previously. After tax profit rose 25 per cent on the back of a 37.8 per cent rise in revenue to to $2.61 billion. The engineering construction division (booking $700 million in, mostly, new iron ore contracts) reported a 56 per cent rise in revenue, and 50 per cent growth was recorded in infrastructure division revenues. Maintenance and industrial services however remained flat.

Importantly, the company noted that operating cash flow was being detrimentally impacted by mining customers lengthening contracts and increasing their payment terms. Chairman John Rubino wrote in his Shareholder letter, “Customer sentiment has changed from an aggressive growth focus to an efficiency focus as commodity prices have normalised in a rising cost environment”, adding, “with market conditions softening…2013/14 will be a year of consolidation

with revenue levels moderating and not expected to reach those achieved in the previous year.”

This is no market for companies with even a sniff of earnings uncertainty. Fund managers have shown they will pay higher multiples for large and even small-cap companies with “annuity style” recurring earnings, and dependable growth, such as telcos, utilities and banks – and punish the rest.

The big problem is nobody knows where the resource sector malaise will end. Trying to second-guess China’s economic strength and short-term commodity price movements is a mug’s game. The best guide is history: the commodity price cycle has a habit of doing better than the market expects on the way up, and worse on the way down – and it always takes longer to play out than investors expect – or should we say ‘longer than investors forget’?

Another certainty is the resource sector being a big ship to turn. Key headwinds for the sector, notably high wages and input costs, are starting to ease as lower demand pushes down prices. The resolution of the federal election on September 7 will help

if the Coalition is elected and reduces green tape and other regulatory and taxation uncertainty (carbon) for miners. And the lower Australian dollar is helping offset falls in US-dollar-priced commodities for local miners and ease some pain.

But these trends will take time to help resource projects. Perhaps in a few years the smart money might recognise the seeds have been planted for the next boom in resource stocks. For now, we believe a slow, painful transition is ahead as the resource sector deals with its own “new normal”.

The other problem is the nature of many mining services providers: high capital investment, high fixed costs, and rapidly depreciating equipment that can sit idle for months. This is a great industry when demand is strong but the sector historically only covers

its cost of capital under boom conditions. It is a terrible sector when projects quickly stop and one must remember that service providers have little flexibility.

MND’s result was strong but such growth cannot be repeated in coming years as the resources investment boom tapers.

As the market obsesses about next year’s earnings, it is worth examining MND’s strategy during this transition period for the resources sector. With revenue slowing, it wants to recruit more of the best talent, improve efficiencies, cut costs and diversify the business into other sectors.

Newspaper reports in August suggested MND might invest in the troubled telecommunications contractor, Service Stream, but MND did not respond to the rumour. It clearly has the balance sheet power to buy weakened competitors and move into other sectors.

Essentially, MND is de-risking the business and positioning it to cope with continuing profit-margin pressure and client demands for more service efficiency. It is a smart strategy, although critics could argue the transition should have happened earlier and that it adds to investment risks.

From a sentiment point of view, strategic shifts that create efficiencies and diversify earnings are not nearly as sexy as big contract wins and can quickly bore an impatient market. But they can also lay the groundwork for the next growth spurt, and reward long term investors who can withstand short term share price pain and volatility.

Overall, the macro outlook for MND and other service provides suggests more profit downgrades and disappointments (as we have been warned about by Boart Longyear), a pick-up in mergers, and even a few companies going into in administration in FY14. It is a brave speculator (rather than investor) who believes mining services stocks cannot possibly fall any further, after savage declines this year.

Value investors must consider whether MND can navigate through these conditions and come out stronger as it uses its balance sheet strength to diversify operations, and mop up weakened competitors. If it can, today’s valuation will look, with the benefit of hindsight, like a rare opportunity.

MND’s record gives hope. The market, of course, always looks forward, but in times of great earning uncertainty it can pay to look backwards as well. Monadelphous’s return on equity, above 50 per cent for the past seven reporting periods, is exceptional.

Its management team is among the best-regarded in the mining services sector, debt is low for a company of its size, and it has a history of under-promising and over-delivering. It has all the hall marks of a Montgomery-qualified business.

The $1.5-billion service provider, involved in large engineering construction projects, maintenance and industrial services, and infrastructure, earns a big chunk of its revenue from blue-chip clients such as BHP Billiton and Rio Tinto. In this market, look for mining services companies that are leveraged to production rather than exploration projects, and to lowest-cost miners that will survive if commodity prices fall further.

The critical question, of course, is whether MND’s valuation fairly reflects these opportunities and threats. Importantly, investors also need to be satisfied that the prospects for intrinsic value appreciation are bright. Speaking with the benefit of some experience, there is a risk of further declines to estimated intrinsic values if the industry doesn’t consolidate dramatically by attrition and price competition becomes irrational.

While MND might be trading at a discount to current estimates of intrinsic value, it is only significantly underpriced if one believes valuations may stabilise from here or rise.

According to consensus forecasts, MND will have to endure falling return on equity over the next two years. Investors should always look for companies heading the other way, with big future increases in ROE and intrinsic value.

MND should have a pole position on watchlists for investors who are comfortable with higher-risk sectors, such as mining services. It is not quite value, assuming a high margin of safety is required, but further falls could be a catalyst for more aggressive fund managers to accumulate the stock.

Importantly, we believe there is time for more conservative value investors to assess the situation. The resource sector’s transition will take a few years to play out, and MND itself could have a year or two of consolidation, before (if) stronger growth resumes.

This article was written on 9 August 2013. All share and other prices and movements in prices are to this date.

by Roger Montgomery Posted in Energy / Resources.

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While The Montgomery [Private] Fund has not held shares in gold producers since 2012, in recent weeks our interest has been piqued. In this article, Tim Kelley talks about the arguments for and against owning shares in gold companies.

Gold is something that has piqued our interest in recent weeks. Since late last year we have seen some precipitous falls in the share prices of gold producers, largely driven by a declining gold price. In fact, looking at a sample of ASX-listed gold companies, the average share price fall since October is close to 60 per cent. It’s beginning to feel like the market may have overreacted.

When we say “gold”, we should add that our focus for the moment is on gold producers, rather than the metal itself. Investing directly in the metal requires a confident view on where its price is going, and for us to have that sort of confidence requires a level of self- delusion that – for the moment – is lacking. More on that later.

We do need to acknowledge that further large changes to the gold price will have a big impact to the fortunes of gold producers, and so we can’t put our head in the sand in respect of them, but if we can see good value in gold producers based on the gold price remaining broadly where it is, that can stack the odds in our favour, possibly enough to justify the risk.

Before you ask, we should also add that Newcrest Mining is not among the companies we are looking at. Newcrest has consistently dismal economics and we have never understood why our peers have been willing to pay the prices it has previously traded.

Today, with the price having fallen by almost 60 per cent since its peak in September 2012, Newcrest still looks expensive in our estimation and our interest in it remains firmly ‘un-piqued’.

What I find more interesting are some of the lower profile gold producers. In particular, companies that may have healthy production growth profiles that the market has lost interest in.

Before we consider their merits, we should return to the gold price. Since October, when it traded at around US$1800/oz, the gold price has fallen by around 25 per cent to now be in the mid US$1300s. During that decline, The Montgomery [Private] Fund has not held the shares of gold companies. In A$ terms however, the decline has been softened by the falling Australian dollar, and the drop in local currency terms is around 17 per cent. This is still a meaningful change, but arguably small compared with the near 60 per cent share price decline for the typical ASX-listed gold

company in the same period.

We can’t exclude the possibility that the gold price will continue to fall. While it is considered a financial asset, gold earns no income, and we know of no reliable way of assessing its “value”. All we can say with confidence is that the current price reflects the market’s best judgement of what gold is worth (for now).

There is a school of thought that says that the gold price shouldn’t fall much further, because many of the world’s gold mines will start losing money at lower prices. The logic says that a gold price below the cost of production would curtail supply, and the forces of supply and demand would drive the price back to a “profitable” level for gold producers.

We’re sceptical about that argument for commodities generally as we have seen many commodities trade below the cost of production throughout history. We are especially sceptical in the case of gold. Most of the gold that has ever been mined now sits in investors’ vaults, and there is nothing preventing those investors from selling it. If they decide for whatever reason to sell, then it can become part of the supply equation, and the marginal cost to remove it from the vaults is close to zero.

In fact, it may well be that the cause and effect relationship runs the opposite way for gold prices. It seems very plausible that a high price would prompt marginal gold mines to start operating and thereby raise average production costs, rather than the gold price being set by the level at which the world’s gold producers can operate profitably.

So we are left with the current market price as our most reliable indication of what gold is worth, and the question we are interested in is: based on that gold price, are there gold companies whose share prices now look cheap based on our best estimate of the potential future profits, and having regard to the risk?

That debate still has some way to run at Montgomery, but we do have a good idea of where we are most likely to find a positive answer. Some of the companies that we will be running our analysis over include: Silver Lake Resources (SLR), Medusa Mining (MML) and Resolute (RSG).

This article was written on 24 July 2013. All share and other prices and movements in prices are to this date.

by Tim Kelley Posted in Energy / Resources.

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According to the commerce department, US Gross Domestic Product rose at a revised 1.8 per cent annualised in the March 2013 Quarter, down from the previous estimate of 2.4 per cent. Excluding inventories, GDP grew at an annual pace of 1.2 per cent. continue…

by David Buckland Posted in Energy / Resources.

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Warren Buffett famously stated, “A rising tide lifts all boats. It’s not until the tide goes out that you realise who’s swimming naked.” continue…

by Ben MacNevin Posted in Energy / Resources.

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