Feature Stories | Dec 09 2021
This story features NEWCREST MINING LIMITED, and other companies. For more info SHARE ANALYSIS: NCM
With the outlook for the gold price positive, analysts find Australian gold stocks underperforming on a historical basis, and outline their preferred exposures among large and small producers and developers
-Outlook positive for the gold price
-Australian gold miners typically outperform internationally
-But have recently underperformed
-Plenty of miners to choose from, with Northern Star the favourite
By Greg Peel
In the four big equity market sell-offs since 2007, physical gold not only generated positive returns, notes stockbroker Wilsons, but significantly outperformed (non-gold) equities during these risk-off events. Across those four periods, Australian gold equities outperformed the market by 40-100% over a 12-18 month period.
While each risk-off event has subtle differences, gold equities do best when fear of higher inflation, and the central bank’s subsequent response, is the overriding narrative, Wilsons notes.
During the high-inflation period of the 1970s, gold equities outperformed the market by 100%.
If a risk-off event is not inflation-driven, the gold price does initially stumble. At times of panic there’s a “sell everything” mentality, and if investor portfolios are under pressure, and subject to margin calls if leveraged, then gold is sold to cover such obligations. But once the initial stage of the crisis has passed, gold equities outperform the broader market in all scenarios analysed by Wilsons.
Subsequent rallies in gold equities are historically powerful, both in size and speed.
Australian gold equities have significantly outperformed global gold equities over the long term, notes Wilsons, largely due to stronger production growth. Since 2006, Australian miners have outperformed global miners by 60% in Australian dollar terms.
But since 2019, they have underperformed by -20%, matching two prior periods of underperformance in 2008-09 and 2011-13. The numbers are nevertheless distorted by the sheer size of Newcrest Mining’s ((NCM)) comparative market cap, such that Newcrest dominates the local gold mining index, and has performed poorly over the period.
Yet the next big miners Evolution Mining ((EVN)) and Northern Star Resources ((NST)) have also contributed to underperformance.
Wilsons believes such underperformance to be overdone, especially when considering the level of production growth on offer. The broker suspects the main issue has been not on the production side but on the cost side, given rising costs of inputs due to supply shortages, and rising cost of labour due to state border closures, particularly in stubborn Western Australia.
Underperformance has opened a valuation gap not seen since 2016, with current gold miner share prices -10-15% below Wilsons’ target prices. There are few sectors across the market which present “clear valuation upside”, and Wilsons suggests the reopening of state borders early next year could be the catalyst to close the gap.
[Note: Wilsons’ report was published on November 25. On November 26, the world was alerted to omicron, which has potential implications for border re-openings.]
Canaccord Genuity notes the performance of the USD gold price has been relatively lacklustre in the face of a supportive macro backdrop, being high inflation, negative real interest rates, rising corporate debt levels, ongoing Fed quantitative easing (albeit about to be tapered) and another big fiscal stimulus injection in the form of Biden’s US$1.2trn infrastructure package.
Canaccord’s analysts believe the Fed’s announcement in November of tapering ahead could prove to be a positive catalyst. This seems counter-intuitive, as more money printing and subsequent US dollar devaluation should be positive for the gold price, and less in the opposite case. But because the market has been pricing in anticipated tapering for some time, Canaccord suggests a relief-rally (buy the fact) may follow.
Indeed since the announcement, the AUD gold price has rallied 5% and Australian gold equities are up 7%.
[Note: Canaccord’s report was published on November 24. Not only was omicron revealed on November 26, the Fed chair chose December 31 to suggest the pace of tapering may have to be increased due to persistent inflation, despite the new covid threat.]
Canaccord highlights the examples of 2013 and 2015, when the USD gold price fell -27% and -10% respectively over the year to December tapering/rate hike announcements, and then went on to rally 16% and 27% respectively in the following three months.
Over those periods, Australian gold equities rallied 41% and 39%.
In 2021, the gold price was down -6% ahead of the tapering announcement in November and the ASX gold index off -14%, which, by comparison, suggests to Canaccord significant upside for Australian miners remains.
Canaccord believes there is substantial upside on offer in the Australian gold sector, with equities offering “deep value” on both a relative and absolute basis.
Brokers’ Preferred Picks
Northern Star Resources ((NST))
Northern Star Resources is Wilsons’ preferred exposure in Australian gold equities. Over the long-term, gold producers that can demonstrate operational excellence, financial discipline in capital allocation, and management teams that understand the importance of both factors tend to outperform. For Wilsons, Northern Star ticks all boxes.
The miner’s merger with Saracen Minerals brought the Kalgoorlie Super Pit under a single owner for the first time in its history, creating the biggest lever in Norther Star’s portfolio to create additional value, Wilsons suggests. In the near term, free cash flow will remain constrained as the miner reinvests into mine expansions, but it is that investment that will lead to growth.
Hence, Canaccord Genuity sees Northern Star as offering “deep value”, and also has the miner as top pick. Northern Star’s five-year plan outlines a strong growth profile, aiming for a 25% increase in production to FY26.
Northern Star is also Macquarie’s top pick among the established producers, due to the organic growth on offer.
UBS this week upgraded Northern Star to Buy, to bring Buy or equivalent ratings among FNArena database brokers to five, with one Hold.
Evolution Mining ((EVN))
Evolution Mining was Australia’s second biggest gold miner before Northern Star merged with Saracen. Evolution is also investing for growth, having recently moved to full ownership of Glencore’s Ernest Henry mine in Queensland, at a price brokers thought was rich but worth it for the growth on offer.
Wilsons sees Evolution as a quality Australian gold producer offering both production and free cash flow growth in coming years, but prefers Northern Star primarily based on greater portfolio optionality long-term and a larger discount to valuation.
The FNArena database shows only two Buys (or equivalent) for Evolution, with five Holds.
Newcrest Mining ((NCM))
By contrast, the elephant in the gold index room, with a market cap dwarfing all others – Newcrest Mining – has six Buy ratings and one Hold on the database. It is more of a valuation call, as Newcrest has proven to be a serial disappointment for investors over the past decade.
Relative to Northern Star and Evolution, Newcrest has suffered a series of issues across operations, execution and financial discipline, notes Wilsons.
The acquisition of Lihir in PNG in 2010 – today 25% of the miner’s asset base — embedded a mindset of growth for growth’s sake. Lihir had little in common with the Australian assets, Wilsons notes.
Newcrest, too, is investing in growth. If it were to push ahead concurrently with four major growth projects under consideration, free cash flow growth would likely be constrained over the next five years, Wilsons suggests, to the tune of around $US1bn of investment each year.
With constrained free cash flow growth and development execution risks across multiple geographies, Wilsons is less convinced the market will re-rerate Newcrest.
Perseus Mining ((PRU)) and other producers
Perseus Mining’s Edikan mine in Ghana has long been beset with issues, and the September quarter past was no exception. But brokers believe recent issues are temporary, and note the miner did very well in keeping costs down.
The same goes for Perseus’ Sissingue mine in Cote D’Ivoire.
The database shows two Buys and one Hold for Perseus, with faith being put in the miner’s Yaoure project, also in Cote D'Ivoire, as production ramps up.
For Canaccord Genuity, Perseus remains a standout pick, given a sector-leading free cash flow yield from a solid and sustainable production run-rate. The broker sees potential for additional valuation levers at Edikan and Yaoure.
Petra Capital notes Perseus offers relative value on enterprise value to production and enterprise value to cash flow multiples. On the same basis, Petra highlights Regis Resources ((RRL)), Resolute Mining ((RSG)) and St Barbara ((SBM)).
Canaccord suggests Capricorn Metals ((CMM)) posted a “remarkable” September quarter, reaching an annualised rate of 83% of its long term production range in its first quarter of production.
September quarter production missed Macquarie’s estimates, but the broker noted the expectation for long term production rates has been reiterated, largely in line with expectations. Macquarie is the only database broker to cover Capricorn, and upgraded to Neutral from Underperform in October on share price weakness.
Capricorn is one of Canaccord’s top picks.
Among established producers, Northern Star is Macquarie’s top pick, followed by Silver Lake Resources ((SLR)), also for organic growth potential, and Westgold Resources ((WGX)) for its operational leverage.
Macquarie recently initiated coverage of De Grey Mining ((DEG)) with an Outperform rating, seeing the miner’s Malina project in the Pilbara as having clear tier-1 asset potential.
Canaccord also has De Grey among its top explorer/developer picks.
Canaccord also has Bellevue Gold ((BGL)) on that list, and Macquarie rates the stock as Outperform.
Macquarie has Aurelia Metals ((AMI)) among its preferred pricks, also rating Outperform, while UBS rates Buy.
Moving further down the ranks into the smaller caps, Canaccord sees OreCorp’s ((ORR)) project as among the best gold developments on the ASX given scale, grade and operating life.
Canaccord suggest Titan Minerals ((TTM)) as a near-term catalyst-rich stock, with plenty of upcoming news to look forward to on assay results at multiple prospects.
Among smaller producers and near-term producers, Petra Capital highlights Red 5 ((RED)), Firefinch ((FFX)), Alkane Resources ((ALK)), which Ord Minnett rates as Buy, Pantoro ((PNR)), Tietto Minerals ((TIE)) and Dacian Gold ((DCN)), which Macquarie rates as Outperform.
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