This article by John Snowden was published in The IRS Report in June 2011.

A return to gold with an Egyptian bargain

Political, market and even meteorological developments have been unusual of late. Wall Street and tech have had great runs, but in the wake of the recent commodity sell-off investors seem more nervous and inclined to put a bit more cash in the bank. Nevertheless, inflation is on the rise in all emerging markets and some developed ones, while the ongoing and increasingly bitter battle between the euro-politicians and the European Central Bank over how to handle the inevitable Greek default has put the euro under pressure as some traders blog about the possible break-up of the euro.

We certainly are in unusual times which got me thinking about gold, often seen as a form of insurance against different types of disaster. My colleague Deborah Owen has signalled the ongoing uptrend in gold (Issue 316) which has benefited from the weakness of the US dollar.

I have never been a huge fan of gold but admit that the metal has certainly earned its keep over the last few years. I go along with the idea that most private portfolios should at least maintain a small holding. My small company portfolio's holding in Centamin Egypt was stopped out in February at 128p at a small gain as investors cut out of Egypt.

The shares had peaked at 196p but lost more than a third of their value amid the political unrest in North Africa and the demise of the Mubarak regime. But the mining operations are somewhat removed from the big city politics, so the company has only suffered from short term interruptions and has been largely unaffected by the political events in Egypt.

The big question for investors now is will private investors' rights be protected. I believe that the answer is more likely yes than no as any new regime, whatever its creed, will want to attract capital and investment into the country.

If they expropriate or damage a business which is fast becoming one of the country's greatest assets, then they will find it much harder to attract new capital. Historically gold production sources have often been located in politically unstable areas. Turning to the past, look at South Africa, Ghana and more recently Sierra Leone.

Centamin Egypt has kept its head down and has recently announced the commencement of ore commissioning activities for its Stage 3 secondary crushing circuitat the Sukari Gold Mine. The ore feed started on 1st May almost two months ahead of schedule. It is anticipated that once commissioning work is completed, the new installation will be capable of delivering up to 5 Mtpa in the third quarter, up from the design capacity of 4Mtpa.

The latest quarterly figures from the Sukari mine showed an impressive record production of 45,204 ounces of gold at a cash operating cost of US$525 per ounce against an average sales price of US$1,405. Production expectations for 2011 remain on target at betwen 250,000 to 290,000 ounces. Due to the events that have already taken place in Egypt, the board feel it would be prudent to pencil in the lower figure at this stage of the year. Also at the end of the period material movement from the open pit and underground operations was reduced due to delays in the delivery of blasting accessories.

On the financials, the first quarter figures released in early May produced a record quarterly operating profit of US$56.1m, boosting cash in the bank to US$185.6m from US$166m and leaving the company debt free and unhedged. There were several non-executive changes with one retirement and three appointments. Two more non-executives will be departing during this current quarter.

Centamin Egypt continues its development into a world class gold mine and as a longer-term investment, leaving aside political considerations, the company must remain attractive. There seems to be a solid floor to the share price around 105p and I would say that between 105p and 125p, the price is forming a buying range.

It is interesting to note thay the chief executive, Harry Michael recently purchased 50,000 ordinary shares for CAD$1.979936 per share (126.6p). Centamin Egypt has a listing on the Toronto exchange, as do many exploration and mining companies. No less than five directors took on board more than 3m shares in the placing in March at 128.87p.

Broker sentiment is broadly positive: out of five brokers that follow the company, three say buy, one weak buy and one hold. The company will be reinstated into the portfolio at the recent price.

The shares featured last December at 35.5p had a flying start, rising to 60p some six weeks later. Unfortunately bad news was around the corner as a rival company, Ceregon Networks Ltd, announced it had acquired Nera Networks AS from Eltek ASA. Nera had been a key customer for Filtronic's point-to-point (PTP) business for several years and Filtronic feared that the deal could have an adverse effect in the form of a significant reduction in PTP sales.

With hindsight it may have been safer to cut the shares and run as the share price crashed back to 38p on the news. However I noted at the time that the PTP sector was changing its product mix rapidly over the next 18 months. The PTP business transition strategy was looking viable, with first production orders received from Selex Galileo for module supply into their electronic radar system. The new lines will result in initial revenues turning into full production in 2012.

The Isotek acquisition, completed last December, has several attractions and is well positioned to participate in several key programmes, especially in the US 4G market. The company has been selected by Alcatel-Lucent as a supplier for both its AT&T and Sprint programmes. Most start-ups experience unforeseen problems and Isotek is experiencing some customer programme delays during the early rollout phase. This will reduce sales for this current year and short term component shortages will affect margins.

For the half year to end-November, group revenues dropped to £7.3m from £9.6m on continuing operations resulting in a pre-tax loss of £1.2m compared with a profit of £0.1m. Cash in the bank dropped to £7.3m compared with £16.3m for the comparative period.

At the interim management review last month, the board stated that sales are projected to grow from £16m in the current year to £25m in 2012. The board, having sounded out customers, forecast a faster than expected phase-out of certain mature module products which would again have a negative effect on trading for the remainder of this financial year into the next.

Due to these varied uncertainties, I am not reinstating the company into the portfolio but as there remain many long term attractions, I will continue to follow events with a view to reinstatement at a later date. Coverage discontinued.

The £2 billion government tax raid on the UK North Sea in the March Budget came as a complete surprise to the oil andgas industry. The plan is to raise the supplementary charge on oil and gas production from 20% to 32%. The net effect will be to decrease investment, increase imports and UK jobs to other non UK sectors of the North Sea. Mature oil and gas fields which already pay petroleum revenue as well as corporation tax, will now suffer a marginal tax rate of 81%.

A broking group commented that the implementation would have little effect on the majors who have large operations in the area as they were small compared to their overall asset portfolios. Specific mention was made regarding smaller independents, namely EnQuest, Valiant and Nautical Petroleum.

Encore Oil, my favourite stock for 2010, has also been hit. The stop on the IRS Report portfolio at 88p was activated as recently as the 17th May to book a 13% profit.

My immediate reaction was to reinstate Encore back into the portfolio but on second thoughts I think it best to wait until we see upward momentum in the share price, since the March budget has forced oil exploration companies and investors to have a general rethink.

Encore now has a portfolio of oil successes under its belt and for the past couple of months has been mulling over how to maximise value without dilution for existing shareholders. In the meantime, exploration to prove up existing funds continued apace. With several wells drilled on Cladhan, thse confirm a sizeable resource of over 100m barrels.

While this drilling activity was going on the board were formulating a plan to maximise shareholder value for investors. A decision was made to form a subsidiary company to float on AIM called XEO Exploration plc, to which Encore was to assign its exploration assets.

Encore had decided to concentrate on its two main assets, Catcher and Cladhan, which should soon move from appraisal to the development stage. The aim was for existing shareholders to partake in an institutional placing for XEO at the same price as the institutions. Encore would also retain a holding in XEO giving existing Encore shareholders an exposure to any future successes. Unfortunately on 23rd May Encore announced that it had decided to cancel the flotation in the light of adverse market conditions and the uncertain climate created by the government's recent tax changes.

In the light of these conditions coverage on Encore will be discontinued for the moment. Stopped out at 88p for a 13% gain.