Gold Producers Over Bullion?

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By Tim Boreham, Editor, The New Criterion

In US Costco stores, consumers can now buy gold bars along with caskets and bulk toilet paper – and they reportedly are in hot demand.

The commentariat reckons this behaviour reflects the anxiety of Americans who fear political instability after November’s presidential election, or even outright conflict as depicted in the hopefully not-too-prescient flick Civil War.

(Zillionaires such as Facebook founder Mark Zuckerberg reportedly are hoarding the yellow stuff, ahead of bugging out to their Doomsday bunkers).

According to the World Gold Council’s Gold Demand Trends released this week, March quarter gold demand rose 3% during the stanza, to 1238 tonnes. But excluding over-the -counter physical purchases, demand actually fell -5% to 1102t.

As always, the gold price is driven by complex and sometimes contradictory factors, including inflation and interest rate levels, central bank buying, and physical demand (as reflected by the Costco hoarders).

Competing flows into cryptocurrencies – an arguably alternative safe harbour – can be thrown into the mix.

Gold’s nexus with interest rates and inflation is quixotic, as higher interest rates are the primary tool for tackling inflation.

Given gold is a store of value, higher inflation is positive for bullion – but higher rates are not. That’s because a lump of gold does not generate income, while higher rates mean improved risk-free cash returns (that is, bank deposits).

After the Federal Reserve started to raise rates from pandemic emergency settings in March 2022, gold duly plunged -15% to a low of US$1630 an ounce in early November of that year.

By April 2023 gold had recovered to a then record US$2048/oz, on emerging expectations that inflation had been tamed. Now, these hopes have proved premature yet gold still deports itself around US$2330/oz (A$3580/oz), just below the April 12 peak of $US2401/oz.

As Europe’s biggest investment manager Amundi Asset Management opines, gold’s rally since the second half of 2023 is “not easy to connect with specific events or fundamentals.”

Amundi investment chief Vinent Mortier says investors are now factoring in rates being held at “elevated levels” for a while longer, to ensure that economies return to “normal” (presumably that means with controlled inflation, yet not in recession).

“The surging gold price appears to disagree,” he says, citing a “tug of war between inflationary pressures (including stalling globalisation and ballooning debt) and deflationary factors (including artificial intelligence-driven productivity and below-par economic growth).”

He adds: “additionally, waning confidence in fiat currencies and a growing defiance against the US dollar are supporting gold.

“Though a major currency crisis looks unlikely in the near term, profligate fiscal policies and diversification away from dollar transactions will steadily draw new fans to gold.”

So how does one become gold’s equivalent of a Swifty?

There’s the pure-play option of buying physical gold in bullion or coin, but buyers pay a discount for the privilege (Costco locally isn’t selling them, but gold shops and kiosks are popping up everywhere).

Less clunky alternatives are gold exchange-traded funds and there are plenty to choose from, such as the currency-hedged Betashares Gold Bullion ETF (QAU) or ETFs Metal Securities Australia (GOLD)

The latter also has silver, platinum and palladium exposures.

There are derivatives such as forwards, futures and options – but don’t try these at home, kids.

Then there are the actual ASX-listed producers who tease the lustrous stuff out of the ground. Given the expense and operational risk of doing so – such as recent weather interruptions – these stocks have lagged the rally in physical gold.

To date the ASX gold index has climbed 6% year to date – approximately half the rate of US$-denominated bullion.

“While this has been driven in part by lingering operational challenges on both the production and the capex/cost front, this environment nevertheless has created an attractive opportunity to invest in the sector at a time when valuations are [discounted],” broker Wilsons says.

The firm says our big three miners Newmont Corp ((NEM)), formerly Newcrest Mining), Northern Star Resources ((NST)) and Evolution Mining ((EVN)) are trading on forward earnings multiples of around 14.5 times – well under the five-year average of 17.5 times.

Wilsons adds the listed miners offer the benefit of “operational leverage” to a rising gold price, given their largely fixed cost bases. “With zero impact to their operating costs, mining companies see a proportionally larger boost in their earnings as their margins expand.”

The ASX gold sector consists of no fewer than 170 stocks, ranging from exploration hopefuls to developers, to producers operating in diverse geographies.

Sticking with the top end, Wilsons likes the aforementioned Evolution Mining, which has gold (and copper) assets here and in Canada. The firm expects the miner to produce 762,000 ounces in calendar 2024, with an industry-low all-in sustainable cost (AISC) of US$832/oz.

AISC is the total cost of producing an ounce of gold, including capital, exploration and administration expenses.

Canaccord Genuity says Northern Star Resources has “exceptional leverage” to rising gold prices, given the scale of its operations (the company guides to 1.6-1.75 million ounces this year).

Mid last year, Canaccord estimated the company would generate $144m of free cash flow in the 2024-25 year, but now reckons $1.3bn-plus is quite doable.

“In our view, this offers the company good optionality around deleveraging, special dividends and potential [acquisitions].”

In the mid tier, Canaccord also has an eye for local producer Ramelius Resources ((RMS)), which spat out a record $125m of free cash flow in the March quarter. The $2.3bn market cap company is on track to produce $300m-plus in 2024-25.

Miners that operate in Africa can expect to be discounted given the extra sovereign risk, but Canaccord believes investors have mispriced the potential of Perseus Mining ((PRU)), which is wrapping up its takeover of OreCorp ((ORR)).

OreCorp is developing its Nyanzaga mine in Tanzania, which will make Perseus a leading intermediate producer of more than 450,000 ounces per annum, at a “highly competitive” AISC of US$1000/oz.

Other ‘goldies’ on Canaccord’s rota are Adriatic Metals ((ADT)), De Grey Mining ((DEG)), Spartan Resources ((SPR)) and Predictive Discovery ((PDI)).

When upbeat sentiment envelopes a commodity, it’s tempting to assume the gold price will keep running as hard as a Pamplona bull during the town’s annual gorefest in July.

That’s a rash assumption, especially if the next Federal Reserve rates move is up, rather than down as the market expects (albeit with less confidence as inflation continues to be stubbornly high).

RBC Capital Markets posits that despite the strong physical demand, geopolitical woes and central bank buying, gold has “inherent vulnerabilities”.

One of these is the lack of flow-through buying into gold exchange-traded funds, a key source of demand in recent years.

Outside of Asia, the firm says, ETF flows have been “squarely negative”. Supporting this, the World Gold Council reports -US$6bn of gold ETF outflows (114 tons) in the March quarter.

RBC predicts an average US$2248/oz price for calendar 2024, peaking at US$2394/oz in 2025 – not much more than the current spot price.

In Warner Brothers’ words: that’s all folks.

So, gold fanboys and fangirls who buy physical gold (or derivatives) in the hope of short-term bonanza gains may be disappointed.

But at the current spot price or thereabouts, any half-decent producer should continue to enjoy fat margins.

When it comes to laying the golden egg, they’re the real geese.

This column does not constitute financial product advice. You should consider obtaining independent financial advice before making any financial decisions.

Content included in this article is not by association the view of FNArena (see our disclaimer).

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