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  Supernova Harmony?

BENJ GALLANDER and BEN STADELMANN

Friday, February 7, 2014

British astronomer Brian Cox said in his BBC series Wonders of the Universe, "There's something a bit odd about the value we attach to gold." It is strange to him because it isn't particularly practical, as most has gone towards the glitz of jewellery.

Even Brian's hero, Carl Sagan, asked the question in his book Cosmos, "Are there planets where the inhabitants proudly display pendants of niobium and bracelets of protactinium, while gold is a laboratory curiosity?"

But the thing going for gold, Professor Cox says, is that it is incredibly rare. Gold is one of the many heavy elements created in the final death throes of only the very largest stars called supernovae. The explosion itself generates mind-bogglingly powerful conditions, just so that, billions of years later, you can lose your wedding band while diving in the Bahamas. Whoopsie.

Scarcity can equal value, and in the case of gold, opinions on that worth tend not to be expressed lightly. You've never heard of biotech bugs — the investors, not the microbes — but almost everyone has heard of gold bugs. The fervour and rigour with which they consistently see opportunity in the metal always makes for a show, so long as the shine isn't too full of pyrites and coprolites.

Last year, when bullion dropped the most in three decades and the big gold ETFs got smashed, they became a much quieter group. We started to hear a lot more from the gold shrugs: those who raise their shoulders in doubt and say, "There are no good reasons for owning it. Why buy?"

Benj was in South Africa for two weeks in the spring of 2013, getting a bit of the lay of the land while speaking at a conference on corporate responsibility sponsored by the Institute for the Study of International Development at McGill University.

The number of mining companies he encountered at the gathering and on his travels gave him some insight into the country and their commodity industry. That set the stage for the purchase in late December of Harmony Gold Mining, the third-largest gold producer in South Africa with production of well over a million ounces in 2012.

The price paid for HMY was $2.42 per share and, being on the big board, it is a very liquid enterprise with a market cap of more than $1 billion. This company offered some diversification for our President's Portfolio both geographically and in terms of currency. The rand is one of the benefits of operating in South Africa, as it has fallen markedly in U.S. dollar terms, making mines more competitive.

There are always reasons for avoiding this investment. With Harmony, one could argue that it is priced for bankruptcy, and indeed, there is palpable risk here. Gold prices have fallen markedly, threatening profitability. In the most recent quarter the company lost 2 cents a share, compared to juicy earnings of 18 cents in the same period last year.

The likelihood of gold dropping further — say, below $1,000 an ounce — is low, but not out of the question. Aside from one mine in Papua New Guinea, 93 percent of HMY's gold comes from South Africa, a country with a history of political and social unrest.

In the last two years, there have been mounting labour problems. Harmony's own Doornkop mine recently had a fire that killed at least eight workers, and there have also been fatalities at the Kusasalethu and Joel mines.

However, what is attractive about Harmony is how it has positioned itself to be a survivor. The grizzled management team is not new to the game and knows how to commit to reducing costs and improving production. Plans have been made to trim expenditures to around $1,100 per ounce by June.

The balance sheet is decent and shares at less than one-third of book value, although writedowns could be coming as restructuring occurs and the decreasing price of gold is recognized. With cash at around $222 million and the bank onside, funding and financing appears secure for the foreseeable future.

The corporation is being prudent when it comes to dividends. They would like to pay one, as has often been the case in the past, but the decision was made to have it come from profits and not debt. So the assumption is that no payout will be forthcoming in the near future.

Ultimately, the price of gold will decide whether the future for HMY is shiny or fades to black. Where will it go from here? It's hard for anyone to know. But there is no question that the sell target of $16.14 envisions a huge move from where AU trades today.

Harmony is unhedged both to the price of gold and the exchange rate, which illustrates the potential upside when market conditions change for the better. And when that happens, oh, how the stars will steal the night away and golden dreams will be shiny days.


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