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Trader Talk

by Mark Allen

FTSE inclusion to affect Randgold Resources?

… Randgold Resources’ share price has historically been highly correlated to the physical gold price, with a coefficient of 0.93, although the two have diverged considerably over recent weeks.

As can be seen from the above chart of the FTSE 100 the index has continued to push higher, with a gain of almost 20% over recent weeks.

Recent economic data has showed an accelerating pace of decline in the US and the global economy, with the US announcing monthly jobless numbers rising by 533,000, the worst figure since 1974.

However, the bears appear to have been exhausted. Optimism about Obama’s turnaround proposal and a bail out of the US car industry has provided support to global equities.

Technical analysis shows the index has posted a fresh short term high and is currently trading marginally above its 50 day moving average. A conclusive break above this could indicate a test of further resistance at 4600. The relative strength index (RSI) has also been in a steady uptrend since early October, which suggests the momentum behind the buying has been building.

Across the pond the Dow failed to break key resistance offered from the long term retracement level at 9000. This is a pivotal level and without this break we could continue to see the Dow and therefore the FTSE continue trading within the recent trading range of 4000 – 4600 and not pushing higher.

Over the holiday period trading volumes tend to drop and it is hard to imagine seeing enough momentum to push through key resistance levels ahead of Christmas.

In conclusion, I believe that over the longer term an upside break is becoming increasingly likely and helps to explain the strong bargain hunting seen every time the FTSE trades below 4000. However, profit taking has prevented the index from breaking significantly higher and with declining volumes I do not see this pattern changing ahead of the New Year, thus leaving a short term sell for the active and a longer term buy on weakness for the more passive investor.

This week marked the annual constituent review for the FTSE 100, with several companies leaving and joining the main index.

Among the new entrants is Randgold Resources (epic: RRS), which is a gold miner focused in West Africa and this is the subject of my article this week. This will be the first time in 19 years that there has been a gold company in the index and reflects the recent relative strength of gold to that of other commodities.

The highest the gold price has been in the rally of the past few years was close to $1030 achieved in March 2008. Gold has since declined around 20% to $828 compared to other commodities, such as copper, nickel and lead, which have fallen nearer to 70% over the same period.

However, demand for physical gold (eg: jewellery being the largest use for gold) has been declining to near the lowest level in the past decade and given current economic condition this does not look set to change for some time.

The weak US dollar and high oil prices are two factors which contributed to the rise in gold earlier this year. However, the change in sentiment of the dollar and huge fall in oil have weighed heavily on gold and with several analysts predicting further dollar strength, the gold price could weaken further.

Furthermore, the number of open contracts traded in gold continues to fall towards the lowest level in over 2 years, which indicates that investors and speculators are less interested in buying gold.

Randgold Resources’ share price has historically been highly correlated to the physical gold price, with a coefficient of 0.93, although the two have diverged considerably over recent weeks.

I believe this divergence is due to the company’s inclusion in the FTSE 100. Randgold will be one of only six miners left in the index, with the others being more diversified producers.

The eviction of the other precious metal companies, Fresnillo and Lonmin potentially means that FTSE tracker funds will need to hold close to a full weighting in Randgold to enable them to closely track the index.

 There is no debating that Randgold is a thriving business. It is cash rich and has a solid track record of finding new deposits and bringing them into production. However, the stock is not cheap and trades on forward multiple of 26x earnings.

As can be seen from the above chart of Randgold Resources the shares have doubled since late October and are trading near all time highs.

The oscillators are overbought, with the RSI and stochastic suggesting the rally is overdone.

I believe the inclusion into the FTSE 100 has over inflated Randgold and given the current divergence away from the physical gold price, I am inclined to suggest the shares may go lower once the hysteria surrounding the promotion dwindles.

At the time of writing the share price is 2791 and my short term prediction is for it to go lower. Near term targets are seen at 2642p, 2560p and 2350p, with a stop loss marginally above the all time highs at 2960p.

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