Commodities | Sep 11 2017
Just when gold prices receive a favourable bump up from global concerns, the Western Australian government has decided to raise its gold royalty.
-US dollar and Treasuries likely to become the safe-haven assets of choice amid accelerating conflict on the Korean Peninsula
-CBA analysts believe higher US rates will eventually weigh on 2018 gold prices
-WA government royalty increase to impact higher-cost miners
By Eva Brocklehurst
Gold prices have come out of the gloom, lifted by rising tensions with North Korea and a more subdued US rate tightening cycle. Demand for gold as a safe haven has increased after North Korea successfully tested a hydrogen bomb and gold futures have lifted over 6% in the last month.
Commonwealth Bank analysts acknowledge the reliability of such demand translating to higher gold prices is not consistent. although a non-financial risk event such as military conflict could be positive for gold. It is entirely possible, they point out, that demand in this case may weaken, even if the situation in North Korea escalates. If that occurs, the US dollar and US Treasuries would become the safe-haven assets of choice over gold.
Meanwhile, the US Federal Reserve may be closer to the end of its tightening cycle. Gold prices and US 10-year real yields have historically held tight inverse relationships, much stronger than the inverse relationship between the US dollar and gold. The analysts believe this relationship will continue to hold up and, hence, a lower terminal Fed Funds rate will drive yields lower and gold prices higher.
The Fed has indicated one more 25-point hike in rates this year is warranted but the US economic landscape has changed somewhat since such estimates were made back in June, the analysts note, as severe storm damage in the south of the country has increased over recent weeks.
One more rate hike by June 2018 is now being priced by the majority of the market. The analysts expect the terminal fed funds rate to plateau at 1.5-1.75%. They believe higher US rates will eventually weigh on prices for gold next year and expect prices to average US$1265/oz and US$1300/oz in the September and December quarters respectively, and US$1261/oz in 2018.
Down under, the Western Australian government intends to raise its gold royalty to 3.75% from 2.50% of revenue from January 1, 2018. The increased rate would apply when the price is above A$1200/oz, which compares with the current spot price of A$1680/oz. Deutsche Bank calculates, at current prices, this would be an additional impost of around A$20/oz, or A$23/oz on long-run price forecasts.
The broker suggests, for the gold miners with Western Australian assets, Regis Resources ((RRL)) is the most affected from both an earnings and valuation perspective. This can be attributed to lower operating earnings (EBITDA) margins and higher WA asset exposure versus peers. Dacian Gold ((DCN)) is also significantly affected, given it has a single asset, Mount Morgans, for which ramp-up is ongoing through FY19.
Macquarie expects higher cost mines will feel the pinch. Operations with cash margins of $400/oz or more will experience reductions in cash profits pre-tax of less than -5% per annum. However, those with a cash margin of just $100/oz or $200/oz would experience a fall of -20% and -10% respectively.
The broker calculates the earnings impact for the lower-cost producers is modest, with earnings falling around -4% in the case of Northern Star Resources ((NST)) and Saracen Resources ((SAR)) and around -3% for Gold Road ((GOR)), Dacian, St Barbara ((SBM)) and -1% for Evolution Mining ((EVN)) and Regis Resources. The broker points out Telfer is bellwether gold stock Newcrest's ((NCM)) only gold mine in Western Australia.
Macquarie notes that since mid July, most Western Australia gold miners have had a strong run up in share prices. The broker makes only modest reductions to earnings estimates to account for the proposed increase in the gold royalty, but has downgraded Northern Star and Saracen Resources to Neutral from Outperform and Regis Resources to Underperform from Neutral recently on the back of share price movements.
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