Material Matters: Strategy, Gold And Gold Miners

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Expectations for the metals market and the impact of Donald Trump's election on gold and gold stocks.

-Base metal prices likely over-reacted as US accounts for under 10% of global demand
-Sell off in Oz gold equities seen more than capturing weakness in gold prices
-Deutsche Bank, Macquarie take constructive views on the ASX gold sector
 

By Eva Brocklehurst

Commodity Strategy

The market hopes, after the surprise win by Donald Trump in the US election, that proposed infrastructure spending will boost demand for base metals. Yet Commonwealth Bank analysts observe that base metal prices have probably over-reacted, as the US only accounts for under 10% of global demand for the major commodities.

China, which accounts for 40-60%, is expected to remain the primary driver of demand for a while yet. With regulators stepping in to lift margin requirements at Chinese commodity exchanges, the analysts expected speculative demand to slow immediately.

The analysts have upgraded price forecasts for iron ore and coal over the next year, amid expectations Chinese demand will remain more resilient and the recent uptick in mining commodity prices indicates deficit concerns are increasing. The analysts still expect prices to ease next year as China steps up to take the heat out of its property sector.

The analysts observe producers are yet to respond to rising commodity prices with much investment in new greenfield project. On current numbers spot prices provide the returns for a number of new projects, particularly in the coal and iron ore market. Yet, miners are justifiably cautious, suspecting Chinese demand for additional volumes may not exist when these projects reach completion in a few years time.

Instead, the analysts observe producers are looking to re-start idled operations, such as the Glencore Integra coking coal mine, where the capital costs are low and the returns more immediate. While the analysts believe miners will remain reluctant investors in new projects for now, should prices remain elevated for another six months they could change their views.

Meanwhile, precious metals are noted to have fared worse since Donald Trump's victory, amid expectations his policies will be stimulatory and increase the likelihood the US Federal Reserve will boost interest rates. The analysts expect the Fed to lift the Fed Funds rate in December and have downgraded gold and silver price forecasts, given the recent deterioration.

Gold And Gold Miners

Market expectations of US fiscal stimulus should lead to higher 10-year bond yields and an increase in inflation, albeit not at the same pace, Deutsche Bank contends. Despite this, the Australian dollar gold price is only 10% below its record high of $1820/oz. Meanwhile, the ASX gold sector has de-rated 25% in the last four months and is now on the lowest multiples since early 2016. The broker believes the sell-off more than captures the fall in the US dollar gold price and expectations of further weakness.

The broker believes the economic advantages in the incoming US administration outweigh the risk factors for now, and the big move in yields has been priced in. Deutsche Bank moves to a more constructive outlook for the ASX gold sector, having previously been bearish.

In a stronger US dollar environment, Australian dollar currency benefits allow the ASX gold sector to outperform global gold peers. The broker upgrades OceanaGold ((OGC)) and St Barbara ((SBM)) to Buy from Hold, and Regis Resources ((RRL)) and Northern Star Resources ((NST)) to Hold from Sell.

Macquarie expects near-term volatility in gold as markets continue to focus on the implications of the election of Donald Trump. The broker remains positive on the medium to long-term outlook and envisages current weakness in the equities as a buying opportunity.

Overall, the broker considers the argument that a Trump economic policy is negative for gold is rather weak, as his policy is not certain and its consequences even less so. After the rise and subsequent fall in gold prices over the election process, the broker observes gold did not fail as a safe haven as investors decided safe havens were not needed.

Moreover, the broker believes gold takes its lead from bigger markets, such as equities, bonds and FX. Markets appear to have decided that, not only is the incoming administration not as worrying, it may actually be economically positive. Macquarie also distinguishes between a more hawkish stance from the US Fed because of a change in personnel and a response to rising inflation. The latter is more plausible at present as the US economy is nearing full employment and wages and prices have accelerated recently.

In a case of where the Fed cannot raise rates as fast as it wants because of political pressure or personnel changes (Janet Yellen's term as Fed chairman expires in February 2018), this would mean faster growth and higher inflation that could get out of hand. Macquarie ascertains that this would indeed be bullish for gold.

The broker's gold forecast already has a constructive view on the US economy and the fact that rate hikes are likely. The broker expects the gold price to rise in 2017. Macquarie notes FY16 was a record earnings season for all the Australian producers and growth should continue into FY17.

The broker continues to favour Evolution Mining ((EVN)) and St Barbara for their earnings potential and strong de-leveraging stories. Northern Star is favoured for its cash generation and aggressive organic growth. Outside of Australian-based producers, OceanaGold is also a key pick for the broker as it is trading at a significant discount to valuation.

Significant falls in the share prices of Alacer Gold ((AQG)) and Doray Minerals ((DRM)) in the past few days has led the broker to upgrade their respective recommendations to Outperform and Neutral. Whilst valuations imply upside for both stocks the broker is cautious over the near-term, given both are engaged in the construction phases of the respective growth projects.

Macquarie also upgrades Regis Resources to Outperform from Neutral. For domestic development exposure the broker flags Gold Road ((GOR)) as it has just secured joint-venture funding for Gruyere and offers low risk upside, as does Dacian Gold ((DCN)) for its Mt Morgans project.
 

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