Johannesburg — THE stock market is distinctly bearish. Even had the Reserve Bank decided to reduce the repo rate, I doubt an interest rate fall would have helped to change bearish sentiment. The fact is that the market has overheated. The more than 30% rise in the JSE overall index over the past 12 months has been way out of line with the investment fundamentals of many companies.
Share prices of many companies were, on the basis of their expected forward earnings, undervalued when the market crashed. However, as an increasing number of trading updates confirm, earnings remain under pressure. In many instances, the "value" has turned out to be less than expected. The expected forward earnings have not materialised.
The market's high overall historic price-earnings ratio, as Jean featured in her Monday Technical Preview, is an all too obvious danger signal of a further slide in share prices.
Don't get me wrong. It's not all gloom but the pinpoints of light are overshadowed by clouds. The global economy is recovering but the price of shoring up the banking system has yet to be paid. Domestically, our economy is in fair, though far from healthy, shape. However, we are about to suffer from Eskom's swingeing tariff increases.
Gold miner Harmony, as reported, expects that its power costs could increase to R3bn - a scary example of the pressures other businesses can expect.
The Private Investor portfolio doesn't hold gold shares, but, for reasons I have mentioned in past columns, holds gold through the exchange-traded fund NewGold. The view is that the gold price should tend over time to correlate with the cost of output of gold. Fundamentally, gold's market price should allow a profit margin for the producers. While this is an economic tenet, it has to be accepted that the gold market is volatile for many reasons and carries the risk that many large central banks and the International Monetary Fund hold lots of bullion. The risk is that they could unload some of their holdings and, in the process, depress the gold price and disturb the correlation mentioned above.
Gold producers, such as Harmony, have not only the risk of a sudden change in the supply- demand shape, but are acutely sensitive to costs of production. If the gold price does not provide a profit margin, Harmony is forced to curb production of low-grade ore and focus on higher-grade ore - if it has this ore. As its shareholders know, the rand price in gold has not increased anywhere near as rapidly as the price in dollars. When its two-year share price peak was R129,50 last February, Harmony's historic price-earnings ratio was over 40, and its earnings yield was 2,51%. At yesterday's closing price of R74,26, its price-earnings ratio was 32,89, earnings yield was 3,11% and it had a minuscule dividend yield of 0,67%
To regard Harmony's share price as having value you would have to expect the rand to weaken to about R12 to a dollar and the dollar gold price to move to about 1500/oz. And this probably doesn't take the Eskom effect into account. Harmony's and other gold-mining shares are not for long-term investment; even defensive investment - they're for trading.
