Commodities | Sep 13 2021
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Are gold equities cheap? Several brokers assess the Australian gold sector, while affected by cost pressures, offers value
-Cost pressures prevail for Australian gold stocks
-Yet the majors benefit as gold price forecasts are raised
-Several mid-small tier gold stocks hold value
By Eva Brocklehurst
Gold equities have underperformed the broader mining sector and several brokers are now reassessing the outlook. Morgans notes sentiment softened recently and moved away from defensive sectors such as gold.
Yet Shaw and Partners points to a gap that opened up between the US dollar gold price and US real rates after the US Federal Reserve's "taper tantrum" in mid-June, and believes the gold price should be trading closer to US$2000/oz compared with US$1800/oz.
As a result, gold appears cheap to the broker and, while acknowledging the long-term price will be influenced by money supply, asserts gold equities are offering value and in absolute terms trading at or near cycle lows.
In addition, the current price of gold signals to Macquarie there is considerable ongoing scepticism about the US Fed's ability to execute on its desired liquidity tapering and subsequently raise official rates.
The broker suspects the path for gold prices going forward will be heavily dependent on data such as US payrolls. Macquarie has upgraded its gold price outlook by 4-5% for 2021-22 and 3-6% for 2024-26 and now expects gold prices to average US$1750/oz in the fourth quarter of 2021 and US$1625/oz in 2022.
Australian gold stocks have also been affected by cost pressures and this is a key theme in brokers' analysis of the FY21 results. Border closures in Western Australia and the strength of the iron ore sector have created labour shortages.
Morgans expects this cost pressure will likely continue until the end of the year. The main issue is the increasing shortage of technical staff, which in turn will affect long-term planning.
Citi notes the ASX gold index has underperformed the ASX300 metals index since early December 2020 despite the gold price outperforming iron ore substantially over the last month. The broker considers gold valuations on a broad base remain elevated, with the exception of Newcrest Mining ((NCM)).
While no two gold miners are alike, Morgans takes account of the scale of production, the jurisdiction and a number of operations into its valuations and concludes the larger miners provide a safer option as production is spread across several operations.
The broker also notes the majors – Newcrest Mining, Northern Star Resources ((NST)) and Evolution Mining ((EVN)) – all have plans for large capital investments in coming years to support growth in production.
Newcrest stands out in terms of annual production and its reserve base, although Northern Star is edging closer to that stock's bellwether status. Still, Newcrest enjoys high margins and has a benefit of strong copper credits which provides some of the lowest production costs across the group.
On this point Macquarie notes a 10% move in copper price forecasts can shift earnings for Newcrest by 12-14% while sensitivity to copper for Evolution Mining is lower at 5-8%.
Macquarie's changes to gold price forecasts drive material upgrades to the outlook for the major gold miners. The broker continues to prefer Northern Star over the other two for ASX100 gold exposure.
The broker's improved pricing outlook has boosted the rating for Newcrest, upgraded to Outperform, and Evolution Mining, upgraded to Neutral. Evolution Mining has a stronger growth profile, with a five-year production growth rate of 10%.
Northern Star has been the most consistent, in Macquarie's view, delivering the strongest overall share price performance, largely attributed to the completion of the merger with Saracen Minerals.
Citi prefers stocks that offer volume growth, free cash flow generation and have positive upcoming catalysts. The broker considers Northern Star has potential for a re-rating as it delivers a turnaround at assets and is the second largest producer after Newcrest with production expected to ramp above 2m ounces in FY25.
FY22 production guidance from both Northern Star and Newcrest was ahead of Citi's expectations, while Evolution Mining's guidance was largely in line, although its capital expenditure plans to achieve growth production at Lake Cowal and Red Lake is higher than anticipated.
While smaller producers may offer more leverage to the gold price or upside from discoveries they are relatively high risk, and Morgans emphasises no metric generates a ranking that fully captures the valuations.
The broker classifies 500,000 ounces as the threshold that separates the majors – Newcrest, Northern Star, Evolution Mining – from the mid tier stocks and assesses valuations are quite flat across the mid tier.
Regis Resources ((RRL)) is just outside the major category, Morgans observes, and while investors weigh up the price paid for Tropicana and the permit risk at McPhillamys, the broker considers the stock is undervalued given its production profile.
Macquarie upgrades four mid-tier stocks on the back of stock weakness and the increases to its gold forecasts, including Regis Resources and OceanaGold ((OGC)), upgraded to Outperform, St Barbara ((SBM)) upgraded to Neutral and Dacian Gold ((DCN)) a double-upgrade from Underperform to Outperform.
Ramelius Resources ((RMS)) remains a top pick in the Morgans stable for those looking for near-term exposure to the gold price. The broker generally considers annual production below 100,000 ounces as a junior producer.
Another small stock, Red 5 ((RED)) is building momentum as it develops the King of the Hills project in Western Australia, and the share price has begun to turn, with the next 6-12 months being critical.
Morgans notes gold stocks tend to experience a lift in share prices on first gold production at a project, yet flags Red 5 as a high-cost producer on an AISC (all-in sustainable cost) basis at the Darlot operation. At the other end West African Resources ((WAF)) is the lowest cost producer.
Junior producers Silver Lake Resources ((SLR)), Bellevue Gold ((BGL)) and Aurelia Metals ((AMI)) are Macquarie's preferred Australian small-cap producer stocks while Perseus Mining ((PRU)) is preferred from a West African standpoint.
Incorporating upgrades to the gold price forecast is positive across the board for the small cap sector, the broker adds. Macquarie singles out Gold Road Resources ((GOR)) as having only modest leverage to the gold price while Bellevue Gold has no exposure until it commences commercial production in FY24.
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