Are Domestic Gold Equities Becoming Interesting?

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-Value may be emerging in Oz gold
-Costs to start rising in 2016
-Few greenfields projects at hand
 

By Eva Brocklehurst

Gold remains subject to the vagaries surrounding the timing of a rise in US interest rates. The market is increasingly punting on an increase in the Federal Reserve's funds rate at its December meeting, with Macquarie noting the market is now pricing in a 70% chance, from 38% just a few weeks ago.

In tandem, brokers have run the ruler over gold stocks to determine where, and if, value is emerging, and some are starting to find the sector interesting again.

The US dollar gold price is currently around 5-year lows, as the pricing in of interest rate rises contributes to gold price weakness. Factors contributing to gold's fall from grace, Canaccord Genuity maintains, consist of both speculation around a US Fed rate hike in December, softer physical demand despite the traditionally strong Indian Diwali season, and the lowering of GDP growth targets in China to 6.5% from 7.0%.

Macquarie contends that such "events" remain the key risk for bullion. These events include how markets react to the US economic trajectory, which could be volatile as slow growth is punctuated by potentially weak economic data (which augurs for higher gold prices). Physical market demands also play a part. Macquarie concurs that Indian demand appears lacklustre while Chinese demand remains robust.

Meanwhile, the Australian dollar price of the precious metal has maintained its year-to-date-average around $1,550/oz, Macquarie observes, as the fall in the Australian dollar has kept pace with the falling US dollar gold price. The broker believes the bear argument on gold is not so compelling for the short term, given the extent to which financial markets have already moved.

Macquarie continues to find value in Newcrest Mining ((NCM)) and mid-cap producers Saracen Minerals ((SAR)) and St Barbara ((SBM)). Gold Road ((GOR)) remains the broker's preferred development play.

In terms of gold stocks, Canaccord Genuity believes the sector is in a malaise but, if the downward correction overshoots, fundamental value may re-emerge among the larger, better quality names. The broker's top pick is Saracen Mineral and St Barbara, as both look to offer attractive price-to-net asset value ratios and St Barbara stands out in terms of its free cash flow.

Deutsche Bank finds valuations more interesting now. However, cost reductions are considered to be largely done and all-in sustaining costs (AISC) are expected to start rising again in 2016.

Based on analysis of its gold coverage the broker expects AISC to decline by 5.0% in 2015. This is based on lower sustaining capital expenditure, with operating expenditure largely flat, after a 12.0% decline in 2014.

In 2016, AISC is calculated to lift by 12% as production growth stagnates. This sector data is skewed, the broker acknowledges, by the presence of major gold stock Newcrest Mining, which has indicated it expects AISC to be up 20% year on year. If Newcrest is excluded, then the average 2016 AISC forecast increase comes back to 1.0%.

Independence Group ((IGO)) is expected to retain its position at the low end of the cost scale while Evolution Mining ((EVN)) and St Barbara are expected to improve on costs significantly.

In addition to lower costs over the past year a relatively higher Australian dollar gold price has also significantly benefitted local gold stocks, as the cash flow has allowed many to consider reinvesting back in the business and exploration has come back into focus, Deutsche Bank asserts. Exploration expenditure is expected to lift 25% in 2016.

In 2016, only Alacer Gold ((AQG)) appears set to invest in a new project – the Copler sulphide expansion – which will result in an increasing production profile, the broker observes.

Other domestic gold stocks are spending on projects which will only allow production to be maintained near current levels. Such projects include Evolution Mining's Mt Rawdon and Edna May, Newcrest's Cadia East and Lihir expansions and OceanaGold's ((OGC)) Didipio mine build.

Nevertheless, by far the clearest trend Deutsche Bank determines is the lack of major greenfields projects in the short to medium term, which is considered to be a result of a lack of capital market/shareholder support in a declining US dollar gold price environment. In this environment companies have looked to grow by acquisition, with Evolution Mining, Independence Group and OceanaGold being recent examples.

Evolution Mining and Alacer Gold are the two stocks Deutsche Bank returns to a Buy rating from Hold, based on valuation. Newcrest Mining is upgraded also, to Hold from Sell.
 

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