Material Matters: Gold, Gold Stocks & Rare Earths

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Potential upside as gold stocks bridge the gap to a surging gold price; plus rising rare earths price forecasts.

-Operational leverage to propel lagging gold stocks higher
-Potential 25% upside for the gold price over the next 6-18 months
-Evolution Mining is Citi’s key pick, copper exposure a bonus
-Higher rare earths forecasts over 2025, prior to 2026 deficits

By Mark Woodruff 

Equities to bridge the gap to rising gold prices

The lagging Australian gold sector, relative to the physical gold price, will outperform over the medium-term based on the sector’s long-run tendency to outperform gold during bull markets, predicts Wilsons.

An attractive opportunity beckons to invest in the sector, suggests the broker, at a time when valuations are trading at a historical discount, aggregate company guidance has been lowered to realistic levels, and consensus earnings momentum is poised to turn positive, in line with the rising gold price.

Even after a recent surge, Wilsons maintains a positive outlook for the gold price – currently trading at around US$2,382/oz.

Citi agrees on the positive outlook, noting an eventual Federal Reserve interest rate cutting cycle and lower long-term yields could provide a more than 25% kicker towards US$3,000/oz over the next 6-18 months.

Gold prices have surged despite several headwinds.

Financial gold demand seems to be playing catch-up with robust physical demand, highlight the analysts at Citi, after prices jumped higher in recent weeks despite a material increase for real/nominal yields, a rallying US dollar and more hawkish Federal Reserve pricing in short-term interest rate markets.

These rate markets are now implying less than two interest rate cuts for 2024 against the March average of three cuts, and early-2024 expectations for six to seven cuts, yet gold has rallied to all-time highs.

On balance, this suggests ongoing Federal Reserve pricing (the broker doesn’t believe hikes are on the table) is likely to be more bullish for precious metals markets.

A decoupling from US rates and the US dollar indicates to the analysts support via robust physical consumption (Indian and Chinese imports), geopolitical hedging, and central bank buying.

While gold mine production should be a record in 2024/2025, Citi suggests this supply may struggle to grow in 2027/2028 based on the current project pipeline.

Consistent with this broker’s 0-3 month and 6–12-month price targets (which were updated at the beginning of April to US$2,400/oz and US$3,000/oz, respectively) the 2024 and 2025 gold price forecasts are raised by 6.8% and 40%, respectively to US$2,350/oz and US$2,875/oz.

Wilsons explains the Australian gold sector is lagging the current gold price partly because of lingering operational challenges on both the production and the capex/cost front, but the benefit of leverage to a higher gold price will outweigh the impact of cost inflation. 

The major advantage of owning gold mining companies during gold bull markets, in the broker’s view, is operational leverage, which can lead to significantly higher returns than merely owning gold.

Mining companies largely have fixed cost bases, and as the gold price increases (with no impact upon operating costs) earnings receive a proportionally larger boost as margins expand.

Wilsons' preferred gold exposure is Evolution Mining ((EVN)), which also has material exposure to copper.

In effect, higher copper prices translate to stronger gold margins for Evolution as copper sales are ultimately credited as a reduction to its gold unit costs. The company’s production is 95% unhedged, aiding strong earnings growth in the event of a gold price rally. 

Being the lowest cost gold miner on the ASX underpins highly attractive margins at the current gold price and provides a degree of cash flow and balance sheet protection against a weaker gold price, explains the broker.

In the current environment of capex/cost blowouts, Evolution’s falling capital intensity is particularly attractive and stands in contrast to peers Northern Star Resources ((NST)) and Newmont Corporation ((NEM)), highlights Wilsons.

Higher rare earths forecasts over 2025, prior to 2026 deficits

As demand from the energy transition rises, supply is becoming tight for key magnet rare earth markets neodymium (Nd) and neodymium and praseodymium (NdPr), highlighted global natural resources specialist Wood Mackenzie, at a meeting hosted by Morgan Stanley.

Because rare earths provide the highest energy conversion efficiencies, Wood Mackenzie (also known as WoodMac) believes they will continue to be utilised for electric vehicles, particularly in the mid-to higher-end models.

WoodMac forecasts the market will move into deficit from 2026, leading to higher prices for Nd and Ndpr over 2025 in anticipation. For dysprosium (Dy) and terbium (Tb), prices are expected to recover in 2025, but decline from 2026 owing to projected market surpluses.

While 85% of battery electric vehicles currently use rare earths, WoodMac sees this figure falling to 70% over the next ten years, and potential for a reduction in rare earth usage for lower-end electric vehicles.

China’s mined and refined supply rare earth quotas for the second half of 2024 will remain in line with the 10-15% increase in the first half, forecasts WoodMac. This level is well below average increase of between 20-25% over the last five years as weak demand has driven down prices since peaking in 2022.

At below US$47/kg for NdPr, WoodMac suggests profits will be marginal for mid/smaller Chinese producers. It’s felt the recent uptick in NdPr prices could be due to increased downstream purchasing activity in China.

While China currently dominates rare earths supply, WoodMac anticipates mined supply will converge to a 50/50 split by 2030 between China and the rest of the world.

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