Harvesting Gold Returns27.03.2018

Since our last Gold Report in July 2017 our superstar Northern Star has delivered a 60% return and our average is close to 35% on our three favourite miners, yet the gold price in US dollar terms has only appreciated 6%. Can this keep going or is it time to take some risk off the table?

BIG RETURNS OFF SMALL GAINS

Last year when we wrote about gold we trumpeted that investors could still get the yellow stuff at a discount of 35% off its all-time highs and there was “no other asset that offers that sort of value”.

Fast forward seven months and the discount is only slightly lower at 30% and we still have the same opinion. Yet there is no doubt that the Australian based gold miners that we favour, Evolution Mining (EVN) and Northern Star (NST) are more expensive. OceanaGold (OGC) is the value pick, having been hit by a combination of sovereign risk and production issues.

Gold bars stacked up

Northern Star and Evolution are among a very small clique of diversified Australian gold miners that also include Regis Resources (RRL) and St Barbara (SBM) that have gone from being “Under the Radar” in a global sense, to attracting huge investment from around the world, in particular from the US. The only other major stock is Newcrest Mining (NCM) which has underperformed because of problems relating to one of its tailing dams and other operational issues.

BIG PRICES FOR AUSSIE GOLD MINERS

In the past 12 months, Evolution Mining has gone from trading at close to its book value to trading at 2.2 times; while Northern Star trades at well over 5 times its book value and OceanaGold trades at 1.5 times its book value (see table below).

A table showing Aussie gold miners

WHY AUSTRALIA IS SO ATTRACTIVE

1. SOVEREIGN RISK
When you read about the threat of nationalisation facing OceanaGold’s Didipio mine in the Philippines you can appreciate why Australia is regarded as being so attractive for this confrontational and hugely lucrative industry.

2.COST CONTROL AND CAPEX DISCIPLINE
In the wake of the commodities price decline from the financial crisis of 2007-2009, like their bulk and base metals counterparts, Australia’s gold miners have cut costs and limited capital expenditure better than most in the world. This can be seen in the falling All-In Sustaining Costs (AISC) which for EVN, OGC, NST, SBM is below US$800 (A$1000) an ounce (see graphic below).

3. BIG DIVERSIFIED PRODUCERS
The quality among the big diversified producers is there to see. You don’t have to look hard. Many of the developers and explorers have not survived the shakeout after the gold price fall in the years from a high in the latter half of 2011 of around US$1900 an ounce to lows of close to US$1000 an ounce in the following four years. The Australian dollar gold price has been kind to the surviving producers; as has their ability to mop up cheap but profitable mines. It’s clear that this consolidation has come to an end for the time being.

A chart showing costs of Australian Gold Producers

When you factor in the Australian dollar gold price of close to A$1700 an ounce, which is also where much of the production for Australian producers is hedged, you can see that the cash flow these companies are producing is phenomenal.

WHAT’S NEXT FOR THE GOLD PRICE?

The short answer is, we don’t have a strong view. Our expectation for the gold price is where it is now.

On the one hand you have an inflationary environment, which means rising interest rates. This puts a dampener on the gold price because it has little productive value. But as inflation expectations rise further gold demand actually goes up because of the increasing uncertainty about monetary policy. There is far more uncertainty about the outcome of interest rate normalisation than nearly anything else in the world.

Well, there is possibly more uncertainty about the state of US President Trump’s mind; and the increasing political risk creeping back into the world. It’s hard to remember a more brazen (and ham fisted) assassination attempt than the recent attack on a former Russian spy Sergei Skripal and his daughter utilising a nerve agent. It’s like putting up the Jolly Roger flag! For as long as such skulduggery occurs, gold will shine.

A graph showing US gold prices in the past 5 yearsA graph showing Australian gold prices in the past 5 years

About the Author

Richard Hemming

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