Gold Views And Stock Preferences

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The company is included in ASX200, ASX300 and ALL-ORDS

 – Reviews suggest gold price will go higher
 – BA-ML introduces two-year target of US$2,400 per ounce
 – Preferred Australian gold exposures highlighted
 – Standard Chartered cautious on short-term technical picture

By Chris Shaw

As noted by BA Merrill Lynch, monetary policy expectations have a significant impact on commodity prices. An example is the recent rally in gold prices, which follows aggressive policy easing by the US Fed and the European Central Bank (ECB). 

Analysis by BA-ML suggests a single month's purchase of US$40 billion in mortgage-backed securities would likely add 0.7% to the gold price within four months. To reflect this, BA-ML has introduced an end-2014 gold price target of US$2,400 per ounce, while retaining its shorter-term mid-2013 target of US$2,000 per ounce. 

These targets reflect the expectation the Fed will continues with mortgage purchases until the end of 2014 and could move to buy Treasury securities at the end of Operation Twist.

In the view of BA-ML, while gold prices have already responded to the Fed move, the open-ended nature of the new policy should see upward pressure on the gold price maintained, at least until employment is strong enough to generate a change in policy. This is considered unlikely prior to the end of 2014.

The upward pressure on gold reflects a rally in inflation expectations, which have surged as the market has anticipated further monetary easing. The increase in inflation expectations in a zero interest rate world has caused a reversal in real interest rates, so making gold more attractive.

With both the Fed and the ECB looking to ease monetary policy further, BA-ML expects commodity prices will push higher. When a weaker US dollar is added to the equation, a continuation of the rally in gold is expected. For BA-ML gold now appears to have a floor of around US$1,500 per ounce, unless any abrupt spike in interest rates puts an end to monetary easing and drives investors out of the gold market. 

Long-term BA-ML's price forecast for gold has been increased to US$1,600 per ounce from US$1,450 per ounce previously, leaving the metal as the broker's preferred commodity exposure. 

To play this, BA-ML favours Regis Resources ((RRL)), Evolution Mining ((EVN)) and Newcrest ((NCM)) among ASX-listed plays. All three stocks are rated as Buy by BA-ML, while Sentiment Indicator readings according to the FNArena database stand at 0.8 for Evolution, 0.7 for Regis and 0.1 for Newcrest.

Deutsche Bank has also reviewed the gold market outlook to account for new easing measures by central banks. The measures appear necessary, as Deutsche notes the world needs growth and policymakers are going to whatever lengths are necessary to achieve such an outcome. 

This has created a situation where 'smart' money needs to adjust to the poor predictability of the current economic environment. One advantage of this in Deutsche's view is investors need look only for what is easiest rather than what is right.

This has implications for gold, as Deutsche suggests Western economies in general are biased towards the idea of borrowing too much and then defaulting rather than paying back what is owed. This implies the most preferable course of action for those borrowing too much is a managed form of currency depreciation though various stages of quantitative easing. 

The 'easy' scenario is good for gold in Deutsche's view, as the price of the metal is likely to continue to respond in a positive fashion to further central bank activity. This leads to Deutsche's forecast the gold price will move through the US$2,000 per ounce level in the first half of 2013.

Growth in the supply of fiat currencies such as the US dollar will play a role in pushing the gold price, while Deutsche also expects concerns with respect to inflation to provide support. At the same time, the current low interest rate environment enhances gold's attraction in the broker's view.

For Deutsche, gold's primary use is as a medium of exchange, making it good money when compared to many of today's fiat currencies. This refers to Gresham's Law, which states when a government overvalues one type of money and undervalues another the undervalued money will leave the country or be hoarded while the overvalued or bad money floods into circulation.

Gold is neither a production nor consumption good, Deutsche arguing if gold had a meaningful commercial use it would make the metal less attractive. Other characteristics of good money are indestructibility, divisibility, transportability and universal acceptability, of which gold possesses all.

One key difference between good and bad money is scarcity, which is where fiat currencies fall short as scarcity can change on the whim of government. In contrast, gold is truly scarce, and the rate of gold supply growth is normally quite slow and predictable. These good money qualities of gold support the Deutsche view prices for the metal are set to go higher. 

Following a recent gold conference, Deutsche Bank has also revised its preferred gold exposures among the mid-cap plays on the ASX. At this end of the market Deutsche prefers Regis, Alacer Gold ((AQG)) and St Barbara ((SBM)), rating all three stocks as Buy.

The attraction of Regis for Deutsche is a solid production growth profile, a solid yield and reliable operations, while Alacer can deliver upside from growth at the world-class Copler asset. St Barbara offers the strongest leverage to gold prices, with Deutsche estimating a 10% change in the gold price impacts on FY13 earnings per share (EPS) by 28%. Alacer shows a Sentiment Indicator reading of 0.6 in the FNArena database and St Barbara of 0.0.

Standard Bank remains structurally bullish on gold, but notes from a more technical perspective the metal price has found strong resistance near US$1,780 per ounce since the Fed meeting earlier this month where further QE measures were put in place.

When assessing the gold price outlook with respect to current market positioning, gold prices relative to stimulus from the Fed and the physical market for bullion, Standard bank's view is gold will struggle to push through resistance at US$1,800 per ounce until sometime in the final quarter of this year.

As Standard Bank notes, COMEX net-long non-commercial positions have almost doubled since mid-August. As well, the current gold price of around US$1,770 per ounce implies more than US$600 billion of QE from the Fed, or 15 months worth of stimulus given the Fed's proposal to purchase US$40 billion of securities monthly.

This suggests gold's fundamentals need to catch up with the price, especially given signs physical demand has slowed as prices have risen above US$1,760 per ounce. In summary, Standard Bank continues to prefer buying gold on any dips, in the expectation a break higher eventually comes and the gold price breaches US$1,900 per ounce sometime this quarter. 

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