I. Sector landscape and outlook
Gold prices continued to rally as investors flocked to buying the safe haven amid escalating rifts between world’s two biggest economies US and China while there is a heightening concern over the second wave of coronavirus outbreak. On August 7, 2020, gold spot prices hit a record high of US$ 2,073.41 per ounce in international markets. Globally, investors have enfolded yellow metal in 2020 as a crucial portfolio hedging strategy. Going forward, expectations for quick V-shaped recovery from Coronavirus pandemic are shifting towards slower U-shaped recovery. Also, potential setbacks from another wave of the outbreak can lead to a W-shaped recovery in the global economy. However, regardless of the potential recovery type, the deadly virus outbreak has a lasting effect on the asset allocation, and it will continue to reinforce the role of the yellow metal as a strategic asset.
While diversification of equity portfolio is something that investors typically eye for, one space that has always remained attractive and stood the test of time through time immemorial is the safe-haven asset, Gold. The yellow metal is considered a safe bet in the international market due to its ability to provide a hedge against systematic risks and non-systematic risks. Gold tends to perform better at the time of global uncertainties, and performs well when an economy thrives; reason being, a thriving economy pushes up gold demand driven by Jewelleries, Coins etc.
COVID-19 Pandemic Impact on Gold and Gold Stocks
The post-COVID ‘new normal’ and a flood of stimulus packages from the Federal Reserve have crushed the dollar and pushed the gold prices to a record high. Investors of all types are piling into safe-haven assets in unprecedented numbers, and when even the most gold sceptic investors are starting to bet big on bullion, one may conclude that things have fundamentally changed.
Oracle of Omaha, Warren Buffett entered into Gold stocks first time in his entire Investment Journey
In August 2020, the Oracle of Omaha, Warren Buffett, disclosed Berkshire Hathaway’s recent investment in gold miner Barrick Gold Corp, A Canada based gold exploration and mining company. This is the first time he has bought gold stock, and it is a sign that the legendary investor places significant value in the yellow metal.
Popular World Gold Mining ETFs have Outperformed Physical Gold Price
Currently, the popular Gold Miner ETFs are outperforming physical gold by ~50%. VanEck Vectors Gold Miners ETF (GDX) has surged over 39.20% in the past 52 weeks. VanEck Vectors Junior Gold Miners ETF has surged over 41%. While in the past 52 weeks, Gold Spot prices have surged approximately 28% and recently surpassed the $2,000 an ounce threshold for the first time. The yellow metal has outperformed other major asset classes this year primarily driven by the coronavirus crisis that fueled apprehensions regarding the global economic growth, which, in turn, sent investors scurrying for safe-haven assets.
Fig 1: Relative Price Performance Gold Spot vs VanEck Vectors Gold Miners ETF
Source: Refinitiv (Thomson Reuters)
Gold outperformed Major Asset Classes in H1FY20
Gold has a splendid rally in the H1FY20, surged approximately 17%, whereas the MSCI World Price Index is featuring a negative price return of 5.48%. Though equity markets around the world rebounded sharply from their Q1 lows, the high level of uncertainty surrounding the COVID-19 pandemic and the ultra-low interest rate environment supported strong flight-to-quality flows. Like money market and high-quality bond funds, gold benefited from investors’ need to reduce risk, with the recognition of gold as a hedge further underscored by the record inflows seen in gold-backed ETFs.
Fig 2: Performance of major asset class in 1H2020
Source: World Gold Council
Record inflows into gold-backed ETFs offset weakness in other sectors
Inflows into gold ETFs accelerated in Q2, taking H1 inflows to a record-breaking 734 tonne. First half inflows surpassed the 2009 annual record of 646 tonne and lifted global holdings to 3,621 tonne. The US dollar gold price gained 17% in H1, following a 10% increase during Q2. The gold price reached record highs in numerous currencies, including euros, sterling, rupee and renminbi among others.
Fig 3: Gold Demand – 1H2020
Source: World Gold Council
However, total bar and coin investment weakened sharply in Q2, leading to a 17% y-o-y decline in H1 demand to 396.7 tonne. 1H2020 jewellery demand slumped 46% y-o-y to 572 tonne as markets remained in lockdown and consumers were deterred by the high price and a squeeze on disposable income. Similar factors were behind a 13% fall in the gold used in technology to 140 tonne in 1H2020, as end-user demand for electronics collapsed.
Australian side of Story
Fig 4: Australia’s gold trade map
Source: Department of Industry, Science, Energy and Resources
Export values increased in the first quarter of 2020
According to the Australian Bureau of Statistics (ABS), Australia’s refined and unrefined gold exports were $5.8 billion in the March quarter 2020, reflecting a growth of 7.0% on an annual basis. Exports were driven by a lower exchange rate (down 3.7 % sequentially) and the higher gold price in USD terms. Australian gold exports fell to a 36-month low in February 2020, to just above $1 billion, as gold exports to China (including Hong Kong) declined by 98 % as the COVID-19 outbreak was at its peak in China. However, with a massive rise in gold exports to the United Kingdom (up 682% on an annual basis) in March 2020, Australian gold exports set a monthly record of $3.3 billion.
Fig 5: Australia’s gold exports, monthly
Source: ABS
Australia’s gold export outlook
Australia’s gold exports are expected to increase by 46% to $27 billion in 2019–20, driven by higher gold prices and increased export volumes. Export volumes are likely to increase by 11% in 2019–20, reaching 362 tonnes, while mine production is expected to increase by 4.3% to 335 tonnes.
Fig 6: Australia’s gold exports by financial year
Source: ABS
Australia’s gold export is expected to increase by 15% in 2020–21, to a peak of nearly $32 billion. The key factors behind the growth would be high gold prices, higher production, which is expected to increase by 11 % and export volumes, which is likely to increase by 15%.
Future of Gold Mining Stocks’ looks Promising
Gold as an asset class has also benefited from the ongoing rifts between the world’s two largest economies, the United States and China. Moreover, a lower interest rate environment after a series of interest rate cut announcement makes gold an attractive alternative for investors holding other currencies. Further, fears of supply crunch with miners halting their operations as per government mandates to stem the coronavirus spread have contributed to the price movement and expected to held prices higher. Higher gold prices are likely to result in improved revenue and cashflow for the gold miners. Further, low oil prices are expected to assist gold producers, in the form of reduced energy costs. With improved margins and cash flows, gold producers are likely to invest in growth projects and/or extend the life of existing mines.
Risk associated to the sector
Safe heaven yellow metal amid challenging times has a long history of being a volatile commodity prone to swift and dramatic price swings. Also, COVID-19 crisis is unique, because it is rare that both equity assets classes and gold hovering at an all-time high. Therefore, if the recent reversal in the equity market despite COVID-19 led damages to turn out to be a secular one, then gold prices can crash, and the fall in the gold stocks could be severe.
Outlook
The COVID-19 pandemic is upending asset allocation, with central banks across the globe have aggressively slashed rates and enhanced asset purchasing programmes to stabilize and stimulate their economies. However, these actions are leading to several negative consequences on asset performance. Further, widespread fiscal stimuli and ballooning government debt levels are raising concerns about a long term run-up of inflation, or significant erosion of the value of fiat currencies. Also, we believe that inflow in Gold-backed ETFs will continue to increase, given the heightened uncertainty in the other asset classes.
In coming days, it is expected that major consumer of physical gold such as India and China which together account for around 50% of consumer gold demand, will sustain demand for the safe-haven yellow metals. The expanding middle class in India and China and broader economic growth is likely to have a significant impact on gold demand in future. Further, the application of gold in the varied number of industries including energy, healthcare and technology is likely to increase. All of these bodes well for the demand of the yellow metal.
The recent rally in gold mining stocks is expected to continue at least in the near- to medium term given the overall volatility in the broader market. COVID-19 pandemic, which has infected approximately 17 million people around the world and fatalities surged to about 0.67 million, has induced unprecedented uncertainty amongst the decision-makers at large. Investment avenues ranging from investment grade to non-investment grade or speculative asset classes, all have significantly underperformed. Amid the falling interest rate environment in the wake of heightened economic uncertainties and increased volatility in the speculative asset classes has brought the safe-haven yellow metal “Gold” into the limelight.
II. Investment theme and stocks under discussion (RED, WGX, KLA and OGC)
After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on ‘Discounted Cash Flow’ method.
- ASX: RED (RED 5 LIMITED)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 538.9 Million)
Red 5 Limited is an Australian gold production company with high-quality assets located in Western Australia and the Philippines.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of ~17% over the current price of 0.285 at 3:30 PM on 27 August 2020.
- ASX: WGX (WESTGOLD RESOURCES LIMITED)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 865.67 Million)
Westgold Resources Limited is an Australian gold production company with a control position in the Murchison Region.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of ~19% over the current price of 2.09 at 3:30 PM on 27 August 2020.
- ASX: KLA (KIRKLAND LAKE GOLD LTD)
(Recommendation: Hold, Potential Upside: High Single Digit, Mcap: A$ 14.79 Billion)
Kirkland Lake Gold Ltd is a gold producer operating in Canada and Australia.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of ~8% over the current price of 72.13 at 3:30 PM on 27 August 2020.
- ASX: OGC (OCEANAGOLD CORPORATION)
(Recommendation: Hold, Potential Upside: High Single Digit, Mcap: A$ 2.12 Billion)
OceanaGold Corporation is a multinational gold producer with assets located in New Zealand, Philippines, and the United States.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of ~8% over the current price of 3.44 at 3:30 PM on 27 August 2020.
Note: All the recommendations and the calculations are based on the current price at 3:30 PM on 27 August 2020. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).
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