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Market Mood
These are uncertain times in global markets, with war tensions in the Middle East, an ongoing power struggle between China and the United States, and a flagging campaign to expel Russia from Ukraine.
At such times, investor interest in gold naturally will rise, for its recessionary hedging qualities.
Gold is now finding trading support above the long-term resistance level of US$2000, and crude oil has undergone a multi-week slide to test 2023 lows below $70 USD/bbl., Figure 1. With the rapid fall in US interest rates, conditions seem ripe for a major gold bull market as a recessionary hedge.
The other key market signal is the recent topping of 10-year US bond yields, which lagged both the top in oil and the bottom in gold, Figure 2. These are warning signs of a possible US slowdown.
Investment Opportunity
While the outlook looks good for physical gold, appetite for stocks remains high, and unemployment remains at generational lows. In this climate, we prefer investment in gold stocks over physical gold.
Ideally, we look for support to gold prices from a higher production cost. The World Gold Council has many useful resources on the gold market. Our favourite is the Metals Focus report of the quarterly average trends for the All-In Sustaining Cost (AISC) of global gold miners, see Figure 3.
Through much of the past three years gold stocks were in a bear market. This happened even though gold prices have been rising since 2019. This puzzle is solved by looking at the difference between spot gold prices and the average AISC, as proxy for miner profit margin, see Figure 4.
The average profit margin as shown in Figure 4, rose from 2015 through 2020, and then fell to a low in Q3 2022. Looking at the overlaid stock price charts, you can see how they started to improve at around the time that the average global ASIC margin bottomed.
Clearly, many factors will drive the gold price, but a key determinant of performance for gold stocks is mining profitability. If costs are rising faster than selling prices for gold bullion, mines struggle to make money. Inflation is good for gold prices, but not good for mining profits.
The average profit margin for gold mining is improving, due to the widening wedge between falling costs and rising gold prices. Expenses like diesel fuel, labour, and explosives fall when oil prices are falling, and the inflation rate is falling. Typically, this will happen once the economy slows.
The ultimate sweet spot for gold miners is a combination of rising gold prices, falling costs, and lower financing costs for mine expansion, or the servicing of debt interest costs.
We seem to be there now, while global demand for gold is supported by central bank buying. Paradoxically, if the Russia-Ukraine war were to enter a frozen state as a result of battlefield stalemate, the BRICS+ bloc central bank buying may well continue, due to sanctions.
Move for this Mood
Our thesis is that a major bull market in gold stocks may be just around the corner. There are some caveats to this investment viewpoint. Firstly, we have yet to see the gold price breakout firmly from the present trading range, capped at around US$2100. Secondly, the operating cost improvement that might drive a broad bull market in gold stocks is still nascent. Thirdly, the appetite for stocks is still strong in the US market. At this stage, we likely should focus on the majors.
In Australia, there are only really three large multi-mine producers with quarterly production above 150kOz, see Figure 5. Newmont (ASX:NEM) is far and away the biggest, being the listed remnant of the merger with Newcrest. This is a comparatively high-cost operation, due to a large footprint in many jurisdictions, with a large number of mines.
Northern Star (ASX:NST) was a darling of the former gold bull market. It grew production rapidly under the guidance of gold mining legend Bill Beament. Operations are now dominated by the KCGM super pit in Kalgoorlie, their Yandal hub comprising Yandal, Thunderbox and Jundee, and Pogo, in Alaska. The new team are focused on realizing higher production rates, at lower second quartile costs.
The third major producer is Evolution (ASX:EVN). They just completed a $525M AUD share placement to institutions to acquire an 80% interest in the Northparkes Copper-Gold Mine from CMOC Group Limited. This offer was placed at $3.80, with a retail Share Purchase Plan (SPP) to follow. This was open to shareholders of record as at 7pm Sydney time on Monday, December 4.
The SPP will likely close on Tuesday, January 16, 2024, and offers a capped price of the lesser of the institutional price of $3.80, or 2.5 per cent discount to the 5-day average price in the lead up to the close.
Note that the Evolution share price is presently trading weaker at $3.615 as at close (December 8, 2023).
For shareholders who already own Evolution, participation in the SPP may offer prices lower than that accepted by institutions in the placement. It is our preferred name among the top three.
In preference order, we like Evolution, Northern Star and then Newmont among the majors.
Perhaps start with the first two.
Disclosure: the author holds both NST.AX and EVN.AX.
Disclaimer
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