Edison predicts US$1,642/oz in 2015
At the time of writing the market is narrowly focused on the possibility of the Federal Reserve’s tapering of QE3 and the assumption that this is inherently bad for the gold price. This report, by contrast, argues that the price of gold is already at a discount to that implied, given the implicit relationship between the two, by the expansion of the US monetary base and that, far from tapering causing the gold price to fall, it will merely cause it to rise less quickly. Currently, Edison calculates a fair value of gold in excess of US$2,000/oz, although it recognises the likelihood of a period of drag while western economies (and the United States in particular) unwind their debt burdens. Key to the prospects for gold will be the interplay between interest rates and inflation. Given the extent of quantitative easing to date, Edison calculates a long-term US dollar inflation rate of 10.7% (discounting a future, sharp reduction in the monetary base), under which circumstances it forecasts the price of gold rising to US$1,642/oz in 2015 and US$2,070/oz by 2020 if real interest rates remain negative. By contrast, a restoration of positive real interest rates would depress the price of gold, and inflation, such that Edison calculates a price of US$1,604 in 2015 and US$1,804/oz in 2020.
In-situ value of mean exploration oz falls 49% in year
Compared to August 2012, Edison calculates that the average value of average ounces has declined 49.2%, from US$45.36/oz to US$23.02/oz. Within that, the values of ‘measured’ and ‘inferred’ ounces have decreased the most, while the value of ‘indicated’ ounces have demonstrated themselves to be relatively robust. Once again, Australia has shown itself to be the market that gives the highest overall rating to gold explorers, although this is specifically restricted to the relatively early stage ‘inferred’ and ‘indicated’ resource categories, while London has once again reprised its role as giving a premium valuation to ‘measured’ ounces. At global average costs of discovery, the delineation of ‘inferred’ ounces is value destroying across all three markets, while the delineation of ‘measured’ ounces is value enhancing only in London. By contrast, only the conversion of ‘inferred’ ounces to the ‘indicated’ category is value enhancing in all markets.
Discount rates rise by 7 percentage points
Compared to 2012, Edison has observed a broadening and (perhaps counter-intuitively) a shallowing of the risk profile in bringing a project into production. That is to say, implied discount rates (as applied to predicted future dividend flows) at the producing end of the spectrum of Edison’s universe of stocks have risen by c 7% on average, while those at bankable stage or before have actually declined. Edison interprets this as reflecting a) a change in the constituents of the sample such that lower quality or distressed companies have been replaced by higher quality ones and b) a tendency by the market to apply long-term pricing assumptions to early stage companies, but spot pricing assumptions to later stage ones.
