Material Matters: Gold, Gold Stocks & Rare Earths

Commodities | Apr 18 2024

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.

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