Weak leads from the US may soften Asian markets

Asian stocks are expected to soften today given weak offshore leads.

Overnight, the S&P500 index shed 0.8% while the Dow Jones Index was off by a similar amount.

Fresh concerns around Europe dominated headlines. Corporate reporting has so far met expectations in the US but there haven’t necessarily been any large earnings upgrades.

Facebook’s profit was lower for the first quarter but this was admittedly on higher IPO related costs. The business is on track to list sometime next month. Price and terms have yet to be finalised.

The Australian dollar was soft ahead of today’s inflation reading, it last traded at 1.0316 against the US dollar. Market expectations are for inflation to come in at 0.6%.

The Euro was last trading at 1.3153 while the US dollar last traded at 81.15 against the Japanese Yen.

Commodities were lower but copper remains in the US$3.60-65/lb band we have been watching now for some time. Gold continues to decline, last trading at US$1638/oz with little safe haven buying amid sovereign debt concerns starting to creep back into the market, albeit only slightly.

Newcrest downgrade, perfection fails to deliver
Australian listed Newcrest Mining released its quarterly production result this morning Asian time. It has reduced its production guidance for 2012 from 2.43-2.55 million ounces to 2.25-2.35 million.

The downgrade might not sound like much on face value but Newcrest is a stock that trades on a very high earnings multiple, with a gold premium built in.

The lower production numbers combined with a falling gold price is likely to hurt earnings estimates which will no doubt be under pressure today. The big problem around this downgrade is doubts around the quality of its Lihir acquisition.

Acquisitions are always difficult and Lihir had a history of burning cash but the hope was that the worst was behind it and Newcrest would bring about better days.

The lesson here is in investing in businesses that are priced for perfection. Prior to this downgrade, Newcrest was trading on a 2012 Price/Earnings ratio of around 17x. This is despite the shares falling by more than 10% over the past few months.

Meanwhile emerging gold producers – sometimes referred to as juniors – are trading on multiples of around half that. For this reason, we think consolidation among the juniors, the producers in particular, will ramp up this year as the market needs a large exposure which can rival Newcrest. There is a large list of Australian gold producers which will stay very profitable even if the gold price continues to decline.