Gold: Rocks versus stocks

The year 2013 is tipped to be the first since 2000 that gold will post a negative annual return.

Gold-mining companies, on the other hand, have managed to consistently underperform gold since 2006, whether markets have been up or down. Investors appear to have given these resources stocks little upside when the yellow metal rises, but handed them severe sentences when it falls.

Anyone wishing to get strategic exposure to the gold price has traditionally had two options: directly purchasing the commodity, or investing in gold-mining equities.

However, one reason gold stocks have not tracked the gold price trajectory has been the introduction of gold exchange traded funds, which give investors easy exposure to gold. In addition, while the business fundamentals of mining companies might, at first glance, appear to be strong, a closer inspection of exploration and capital expenditures reveals a different picture. Now the gold price has plummeted, gold-mining firms that took on debt and stretched to attempt long-shot projects are in trouble, as the costs associated with digging increases.

And a lack of new discoveries, coupled with deteriorating brownfield projects, have left miners with production and cost gaps that have undermined their performance.

The write-downs have already begun - gold companies will have reduced the value of their assets by about $17 billion (£11 billion) in the past 16 months, according to data compiled by Bloomberg.

"Write-downs [are] to be a significant theme in the gold space," a recent Credit Suisse report states.

Jefferies analyst Jake Greenberg echoes this view: "It seems obvious that a storm of write-downs is coming from the gold-mining industry. It is not too late to be short these names on this write-down theme."

Research by Deutsche Bank notes that at $1,300 per ounce of gold, "a vicious cycle emerges forcing companies to likely raise equity to bridge a growing funding gap until they 'right-size' costs to the new gold price".

Stockpicking opportunities

But analysts at Peel Hunt stress that opportunities exist for stockpickers, highlighting companies "positioned well for a future re-rating". They believe Amara Mining (AMA) is such a company.

"Amara's evolution over the past year has created a focus on execution and technical excellence; which in turn, has delivered a strengthened growth pipeline," the analysts explain. "Amara demonstrates progress and offers catalysts for a re-rating at a time when many peers are stagnating.

"It is positioning itself to be one of the stand-out performers in the junior gold space."

Mwana Africa (MWA) and Shanta Gold (SHG) are two other such players, according to Peel Hunt. On the former, the broker comments: "Mwana has now delivered on the promised diversification of its revenue stream. This, and the wider appeal of the assets, has been overshadowed by concern over geopolitical risk in Zimbabwe."

On the latter, Peel Hunt says: "We consider Shanta Gold represents a compelling investment opportunity, as new management focuses on delivering production at the New Luika mine.

"We believe the financing and commissioning challenges of 2012 are a thing of the past, and that Shanta Gold, with an adequate and growing cash pile, will begin to be acknowledged by investors for the attractive returns that it offers."

The broker adds: "Investors who reach this conclusion earlier than the market will enjoy significant upside."

AIM-listed gold explorers are ten a penny. They include Archipelago Resources (AR.), Greatland Gold (GGP), Kirkland Lake Gold (KGI) and Rambler Metals and Mining (RMM), to name just a few.

For a FTSE 250 player, Peel Hunt recommends Centamin (CEY), driven by the belief that the current legal challenges the company faces with respect to its operating licence in Egypt are likely to reach a favourable conclusion in 2013, leaving the miner to concentrate on delivering capacity expansion at the Sukari mine.

"Centamin can be best described as a great asset operating in a challenging and uncertain operating environment," the broker adds.

Other mid-tier gold miners include Randgold Resources (RRS) and Petropavlovsk (POG).