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March 23, 2012 9:30 pm

In gold mining, unexpected is not uncommon

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When it comes to losing investors money, equities have an endless scope to surprise. On Thursday, for example, the recent death of Colonel Muammer Gaddafi ended up costing the hedge fund manager John Paulson about £8m.

An uprising among Tuareg mercenaries returning to Mali, recruited and armed last year by the former Libyan leader, this week triggered a military coup in the west African nation. Randgold Resources, the Mali-focused gold miner, dropped 13 per cent in response.

It was another setback for Mr Paulson, whose hedge fund was still adding to its 1 per cent stake in Randgold during the fourth quarter. But how many investors could have anticipated this chain of events following the revolution in Libya? Judging by Randgold’s share price, not many.

Before this week, Randgold was one of only two London-listed large-cap gold miners to outperform the price of bullion over the past three years. The stock had risen 86 per cent, against a 77 per cent rise for gold over the same period, and had been trading in lockstep with gold over the past six months. But, with its Mali mines expected to provide at least two-thirds of Randgold’s production this year, news of the military coup left the shares lagging the gold price by 14 per cent since 2009.

Such events may be unpredictable, but they have not been uncommon.

Egypt’s revolution has cost shareholders of Centamin 42 per cent over the past year as the miner struggled with strikes and shortages of explosives. African Barrick Gold, down 24 per cent in a year, suffered after an mob armed with machetes attacked is mine in Tanzania. Randgold itself was under pressure in late 2010 as violence followed a disputed election in Ivory Coast.

All of which may leave investors wondering why they should get involved with mining companies at all. Even without such “black swan” events to waylay the investment case, the political, technical and managerial risks still mean stocks rarely beat bullion.

Physical gold has outperformed global gold equities 82 per cent of the time over the past 10 years, according to Citigroup.

“Markets are telling us that gold stocks are boring,” says Johnny Martin-Smith, an analyst at Westhouse Securities. “They react to bad news with alacrity and good news with a yawn.”

Supporters point out that physical gold does not provide a yield. Gold miners have been boosting dividends in the hope of attracting investors away from exchange-traded funds and similar vehicles offering a more convenient way to bet on bullion.

Yet the sector remains some way from offering the kind of payouts that would attract income investors. In 2011, dividend yields for the gold producers were less than half the average for the mining sector at 1.3 per cent, according to BMO Capital Markets.

And a rising gold price is unlikely to result in improved dividends, warns Citi analyst Johann Steyn.

“Companies have to spend more and more capital to fight declining reserve and production profiles,” he says. “Shareholders seldom share in the upside of margin expansion.”

Citi recommends investors favour smaller gold prospectors, which it says offer more exciting growth prospects than the majors.

Avocet Mining, the only London-listed large-cap gold miner to beat the bullion price over the past three years, certainly matches that definition. Previously Aim-listed, Avocet entered the FTSE 250 this month, having gained 135 per cent over the period. Annual earnings per share are up fivefold and estimated gold reserves at its flagship mine in Burkina Faso have doubled since June.

But much of the growth is already in the price. Avocet trades at about 16 times 2012 earnings forecasts, compared with an average of less than 13 times earnings for both the emerging producers and the majors. By contrast, African Barrick has dropped to 10 times this year’s earnings forecasts, while Centamin trades at just 6 times 2012 profit.

Avocet investors may also wish to note that Burkina Faso’s government has been overthrown four times in the past three decades.

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