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Market Gave No Quarter to Gold Equities


While physical gold rose during the first quarter, gold equities fell and may keep on falling.

Gold ended the first quarter of 2012 with a gain of more than 6% after falling 7.5% in the fourth quarter of 2011. Admittedly, its momentum seemed to stall after the February 29 correction.

Gold equities, on the other hand, fell hard. Now, many are questioning whether they're still overvalued.

The Gold Bugs Index (^HUI), whose largest components include Goldcorp (GG), Barrick Gold (ABX), and Newmont Mining (NEM), fell 9.44 in the first quarter, while the Market Vectors Gold Miners ETF (GDX) was down nearly 8% in the first three months of 2012.

Although the loss for junior miners was less steep than that of their large cap counterparts, the Market Vectors Junior Gold Miners ETF (GDXJ) still posted a nearly 6% fall in the first quarter of 2012.

This follows a rough year for gold miners, as the HUI took a 12% tumble in 2011, compared with a 9% gain for the gold price.

According to Bloomberg data, the gold sector's woes compare to a 12% gain for the S&P 500 in the first three months of the year, with the index climbing above gold by the most in more than 10 years in the first quarter.

Individually, Goldcorp ended the quarter down 1%, Barrick Gold fell 9.9% in the first quarter, and Kinross Gold (KGC) tumbled 21.5% in the first three months of 2012.

In comments recently made to Canada's Financial Post, Goldcorp chief executive Chuck Jeannes said that "there have been a series of bad news events for some of the peer group that have scared investors in our space."

Indeed, Kinross reported a $2.9 billion write-down on its Tasiast mine in Mauritania when it announced its fourth-quarter results in February, and, similar to many of its counterparts, said it was contending with a 16% increase in production costs in the fourth quarter as a result of increased labor, diesel, and power costs. Last Tuesday, Centerra Gold's (CG.TO) share price tumbled more than 15% after it lowered its 2012 production forecast for the Kumtor mine.

But in his February monthly commentary on the gold market, Joe Foster, portfolio manager of the Van Eck International Investors Gold fund, noted that while gold miners' struggle to control costs "has been the main reason that gold companies have periodically missed expectations, which has disappointed the market and caused some to underperform the gold price," escalating costs do not reflect poor management, bur rather cost inflation similar to inflation at the gas pump.

Costs are a huge issue in the gold mining industry, he says, but those who focus solely on costs risk missing the larger picture – namely, the sector's profitability.

"Operating costs have risen 15.8% annually since 2003, but the gold price has risen 19.8% annually over the same period. Profit margins have expanded, dividend yields have increased substantially, and companies are able to fund all of their capital needs internally," he notes.

"Fundamentally, the current valuations just don't make sense," Foster said last month via Bloomberg. "We're just looking for a catalyst to make that happen."

However, not all analysts seem to be bullish on gold equities at the moment. RBC removed Barrick Gold and Harmony Gold (HMY) from its mining "best ideas" portfolio, according to Reuters, as it downgraded the precious metals sector from "overweight" to "market weight" earlier this week as a result of expected weaker demand from India, as well as the diminished likelihood for more quantitative easing in the United States.

Pawel Rajszel, a gold and energy investment analyst with Veritas Investment Research in Toronto, says that the gold sector is currently the most volatile sector on Canada's TSX, after the information technology sector, and he currently has six sells out of the eight gold companies he covers.

Over the long term rather than quarter-to-quarter, Rajszel says he expects gold prices to decline much further, which he says will squeeze producers' margins and makes it difficult to be bullish on gold stocks.
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