Opinions Divided on Australian Gold Stocks

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This story features NEWCREST MINING LIMITED, and other companies.
For more info SHARE ANALYSIS: NCM

By Andrew Nelson

There’s little arguing that gold prices have started off the year on a fairly positive note, with prices pushing to one-month highs at US$1160/oz, which is less than US$70 shy of the all-time high reached in early December. Yet while prices were supported last year by a surge in investor appetite and the swing in official sector flows and closures of hedged gold sales, the question remains: can the physical market continue to rise in 2010?

Where gold goes, so do gold miners. For analysts at Deutsche Bank, gold remains a preferred sector and commodity and while the metal is trading in line with the broker’s 2010 forecast of US$1,150/oz, a 2011 forecast for US$1,250/oz certainly leaves room for upside. Yet while the broker sees continued support coming from central bank diversification of reserves and investment holdings, it believes the US dollar could become increasingly less helpful in the year ahead.

The gold price has been rising fairly steadily since April 2001, making it the longest lasting rally in the metal since it became freely floating at the beginning of the 1970s. In fact, notes Deutsche, the current rally is almost three times as long as the last four rallies in the gold price. However, a significant part of the rally in the gold price over the past few years has been driven by the weakening of the US dollar.

Yet with the Fed expected to start a programme of rate hikes during the second half of this year, the broker still holds some hope that the greenback will remain structurally weak, which makes another fall in the US dollar during 2011 as a possibility. The broker cites the last three Fed tightening cycles, where the US dollar tended to strengthen in the six months before the rate hike and then give up these gains in the six months following the first Fed rate hike.

Deutsche Bank sees other factors as likely to have some significant positive impact over the period where it sees assistance from the US dollar as slipping. Central bank buying, stable investment holdings and potential US action to curb speculative activity could well support gold in the near-term absence of US dollar weakness. The broker also notes the recent sale of gold by the IMF to India, while relatively small, is still significant, given it indicates Asian countries are increasingly prepared to diversify reserve holdings.

Deutsche points out that collectively, Asian country gold holdings are small, sitting at around just 10% of G10 holdings. For the first time since 1988, the broker thinks there will be net central bank buying of gold seeing emerging market purchases surpass selling by European Banks.

On the investment side, the broker notes that ETF holdings have been stable, but could well be boosted by legislation aimed at reducing speculative activity in commodity markets.  Lastly, Deutsche notes that near-term US rate rises and thus a stronger USD are not a done deal. With China continuously beating expectations, the pressure to allow the Renminbi to appreciate is growing. This, coupled with US economic data that for the most part remain unimpressive, means that future Fed rate rises may well be kept at bay, putting pressure on the USD and benefiting gold.

While the broker has Buy ratings on both Newcrest ((NCM)) and Lihir Gold ((LGL)) given they are both long life, low cost and hedge free, Deutsche sees Newcrest as being the better option as it has the best production growth outlook over the next 12-months. The broker also thinks that Lihir may well range trade until a new CEO is found.

Looking at the mid caps, Deutsche thinks that Avoca Resources ((AVO)) – also a Buy – has three near term catalysts that could well provide some share price upside when coupled with a gold price at current levels. The broker notes the potential control of Dioro Resources ((DIO)), an open pit feasibility study and the real possibility of reserve upgrades. These, says Deutsche, should help offset market concerns about a flat production profile and short mine life.

On the other hand, analysts from Credit Suisse are taking a polar view when it comes to the gold sector in 2010. The broker’s latest supply/demand modelling for the global gold sector has lead it to take a bearish stance on the gold price in 2010. Citi has increased its 2010 gold price forecast, but this is based on a spot price it sees as being well beyond what can be justified by any fundamentals.

Citi believes the biggest influences on the gold price in 2009 had very little to do with the structural supply/demand factors such as declining grades, reduced discovery rates, and increased unit costs of recovery. All of which point to downside for producers. Rather, Citi analysts feel the last year has been about USD weakness and market sentiment, which together drove investment demand. However, the analysts see both of these influences waning in 2010, leaving gold price to contend with the above mentioned structural supply/demand factors.

After its latest modelling, Credit Suisse now expects a 420 tonne surplus in 2010, this is up from 110 tonnes previously. The broker’s full-year 2010 price assumption is for US$1025/oz, which is around US$130/oz below yesterday’s spot. It should then be unsurprising that three of four of the Australian gold stocks covered by Credit Suisse are rated Underperform, while Newcrest is rated as Neutral.

The reason Newcrest remains Credit Suisse’s preferred gold exposure is that it sees near-term upside risks from the spot copper price, which is now 18% above the broker’s CY10 forecast. Among the smaller gold exposures, Credit Suisse prefers Andean Resources ((AND)), which is unlikely to be swayed too much by short-term gold pricing as the company is still a couple of years from first production.

An update on the gold outlook by Barclays Capital Markets last week seems to support the Deutsche argument more than the one from Credit Suisse. Barclays predicts gold prices will average US$1180/oz in 2010, although the English bank admits that a strengthening US dollar could flush out the remaining less-committed speculative longs in the near term.

Beyond the short-term corrections this would bring about, Barclays believes the broader dynamics that have expanded gold’s appeal over the year past, like concerns over economic recovery, low interest rates, the potential of spiralling inflation or even further US dollar weakness, will only serve to buoy investment demand.

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