Commodities | Jul 14 2023
This story features NEWCREST MINING LIMITED, and other companies. For more info SHARE ANALYSIS: NCM
Some brokers are increasingly warming to the opportunities provided by investment in Australian gold miners.
-Gold offers portfolio diversification
-Gold miners outperforming the gold price
-M&A activity stepping up
-Gold ETFs saw outflows in June
By Greg Peel
Australian gold miners have demonstrated strong long-term performance, notes Wilsons. Over the last 10-20 years, these miners have outperformed the ASX200, given leverage to the gold price while capitalising on Australia's rich gold reserves and favourable mining conditions (mostly).
Their ability to preserve value and deliver positive returns over extended periods reflects the growth potential offered by ASX-listed gold miners, says Wilsons. And gold miners exhibit a low correlation with the ASX200, presenting an excellent diversification opportunity. Due to their unique characteristics and industry-specific factors, the performance of gold miners tends to be independent of the broader market.
Gold and gold miners serve as effective hedges against risk events and periods of significant market downturns, notes Wilsons. In times of economic uncertainty, geopolitical tensions, or financial crises, investors seek the safety of safe haven assets like gold. The gold mining industry's historical resilience during market stress makes Australian gold miners an attractive option for hedging against adverse market conditions and protecting portfolios from downside risks.
As physical gold pays no return to the holder equivalent to an equity dividend or bond coupon, the price of gold is exposed to the cost of money. The higher the cost of money (interest rate), the more a holder is losing in real terms on a static gold price.
Hence the USD gold price retraced significantly in FY22 as the Fed launched the most rapid rate hike cycle in history. But the Fed is supposedly close to bringing that cycle to an end. USD gold has been a solid performer in FY23. As the Fed has hiked to a higher level than the RBA, the Aussie dollar has fallen over the period, thus supporting the price of AUD gold.
Wilsons suggests the prospect of the Fed pausing and then cutting rates should drive further upside for the AUD gold price in the next 6-12 months, although the Fed remains determined to keep rates higher for longer (without offering a timeframe).
Production & Exploration
Investing in listed gold miners offers not only exposure to the gold price, and to dividends, upside is provided through production and exploration. Increasing production over time allows for revenue growth without reliance on the gold price.
Increasing production and a rising gold price can be a powerful combination for share prices.
Gold miners exhibit operating leverage to the price of gold due to their fixed cost base. Therefore, an incremental increase in the gold price directly impacts their bottom line, resulting in a proportionally larger boost in earnings for gold miners, Wilsons points out. This leverage results in gold mining companies, on average, outperforming the price of gold itself during a gold bull market.
But it works the other way during a bear market/declining gold price. And spending on production expansion can limit the free cash flow generated by a company’s operating mine(s).
Right now, another positive for Australian gold miners is an upswing in M&A activity. This is most notable among smaller miners, particularly those operating in a same area and thus offering synergies from a combined effort. But as American gold mining giant Newmont’s attempt to acquire Australia’s biggest gold miner, Newcrest Mining ((NCM)), attests, you don’t have to be small to be a target.
Goldman Sachs expects ongoing interest in Australian gold assets following recent activity, with increasing focus on emerging, high-margin mid-caps or synergistic opportunities as broader industry consolidation continues.
Goldman expects new projects/project optimisations across a number of assets, combined with recovery from one-off impacts (weather), to support near-term production growth across the sector. The broker’s analysis of more than 30 listed Australian gold assets suggests industry cost inflation may be easing (though stickier for underground mines).
On pricing, Goldman’s global team sees macro factors supportive for gold pricing, while hedging roll-offs also support company realised pricing.
The Australian gold sector is up around 10% year-to-date at early July, with the AUD gold price up around 6% to $2,900/oz, though performance has varied across stocks with weather/availability impacts and cost inflation, notes Goldman.
The broker has initiated coverage of six listed gold miners, resulting in a Buy rating for Evolution Mining ((EVN)), Gold Road Resources ((GOR)) and Regis Resources ((RRL)), and Neutral for Northern Star Resources ((NST)), Capricorn Metals ((CMM)) and De Grey Mining ((DEG)).
Wilsons has made a strategic decision to replace Northern Star with Evolution Mining in the brokers’ Focus Portfolio, believing Evolution now presents a more compelling investment opportunity. Evolution stands out due to its attractive valuation metrics, better production growth, and its exposure to copper.
The Argument Against
Macquarie covers 16 listed Australian miners. Of those, ten attract Outperform ratings and three attract Neutral ratings. Aside from current research restriction on two miners, Macquarie has only one Underperform.
Macquarie has Northern Star as Outperform. The broker downgraded Evolution in April following a strong share price rally.
Macquarie is also not that keen on the gold price over remaining 2023 and into 2024.
Earlier this year the broker had predicted gold could reach US$2075/oz, but it peaked out at US$2030/oz and is currently at over US$1950/oz. Macquarie puts this down to several factors:
The easing of US regional bank sector concerns; a relatively “low stress” increase to the US debt ceiling; the market changing its mind about second half 2023 Fed rate cuts, given a recession is still yet to be evident; and a firm US dollar.
Macquarie does not believe the global rate-hike cycle is over yet. The Fed, ECB and others (RBA) are determined to stay the course to bring down inflation, which implies rising real interest rates and a stronger US dollar. Thus while Macquarie’s commodities team has lifted its 2024 gold price forecast by 4%, the broker’s equity analysts still expect gold price softness over the second half of 2023 and through 2024.
The analysts top picks are Northern Star, for its organic growth, Ramelius Resources ((RMS)), for its cash flow growth, Bellevue Gold ((BGL)), moving to producer from developer, and De Grey Mining for its exploration and development potential.
Developed market central banks are nearing the end of their tightening cycles, suggests the World Gold Council, somewhat in contrast to Macquarie. For now, market consensus points to a mild economic contraction in the US in late 2023 and slow growth in developed markets. But given the historical lag between monetary policy and economic performance, investors are wary that a hard landing may be still to come.
In this context, and following gold’s positive returns in the first half, the WGC expects gold to remain supported on the back of range-bound bond yields and a weaker US dollar. Gold should experience stronger investment demand if economic conditions deteriorate. Conversely, a soft landing or much tighter monetary policy could result in disinvestment.
Global physically-backed gold exchange-traded funds experienced net outflows in June, notes the WGC, calling a halt to a three-month inflow streak.
Having peaked at over US$2000/oz in mid-May, the gold price fell to just above US$1900/oz by end-June.
The early June strong equity market performance in key markets likely shifted focus away from risk-off assets such as gold, the WGC suggests. And the majority of outflows occurred when the gold price dropped during the second half of the month amid hawkishness from major central banks in the face of obstinate inflationary pressure.
North American fund flows turned negative for the first time in four months, WGC notes, losing -US$1.7bn in the month.
Although the Fed paused its aggressive rate-hiking path in June, a higher interest rate projection from the board and Fed chair Jerome Powell’s recent hawkish statements pushed investors’ rate expectations steadily higher.
As a result, the allure of gold ETFs – already dented by gold price weakness – waned. Meanwhile, the rally in US equities delivered a fourth consecutive monthly gain, further distracting investors from gold ETFs.
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