Gold Sector: Gold softens but strong margins remain

About the author:

Mat Collings
Author name:
By Mat Collings
Job title:
Research Analyst
Date posted:
30 November 2020, 2:30 PM
Sectors Covered:

  • We refresh our three gold names valued on a flat forward gold price, using US$1,750/oz and 0.74 AUD/USD (from US$1,900 and 0.725).
  • The gold price has softened on the back of increasing global confidence as Covid-19 vaccine developments make progress.
  • The path to normal remains rocky and we think markets are too upbeat on vaccine timing – we expect volatility will create trading opportunities.
  • While improving global sentiment may push gold prices lower, central bank stimulus measures (i.e. money printing) need to be watched as a counter-balance.
  • Stocks appear oversold compared to our revised price targets. We retain an ADD rating for Ramelius Resources Limited (ASX:RMS), Red 5 Limited (ASX:RED) and Regis Resources Limited (ASX:RRL), although weakness may persist in the short term, with RMS our preferred stock from the group.

Margins reduced but still high

Despite the softening gold price, and relative strengthening of the AUD, the AUD gold price remains around A$2,450/oz at the time of writing, and we update our modelling to A$2,364/oz.

At this price, most gold companies are still earning close to A$1,000/oz of gold produced compared to their all in sustaining costs.

We see the current falls in gold stocks as driven by investor sentiment rather than a change to the underlying fundamentals of the gold producers and their profitability.

Uncertainty still looks like the only certainty

There are likely still tough months ahead for the global economy. Northern hemisphere winter is approaching and though vaccine trials are promising the market appears too upbeat on the timelines for approval and deployment.

Recent market moves appear to be glossing over the difficulties still ahead, with signs of a full bull market as fund manager cash levels hit new lows.

Volatility will create trading opportunities as sentiment shifts.

Our valuation methodology

We have moved our base case gold price to US$1,750/oz and our AUD:USD exchange rate to 0.74.

We value the junior and mid-tier gold miners using a flat forward gold price, reflecting our view that these stocks respond quickly to moves in the spot gold price and sentiment rather than to long term price forecasts.

Sensitivity tables are included for gold price and exchange rates to provide an insight on the potential upside and downside.

We retain Add ratings across the gold stocks and our target price moves to $2.44 from $2.86 for RMS, to $0.41 from $0.52 for RED, and to $4.57 from $5.74 for RRL.

What next?

We expect the shift away from gold stocks to persist in the near term with investors looking for a rebound in Covid-19 impacted stocks as vaccine researchers continue to report positive progress.

As gold companies report Q2 production and earnings in January, we think the strength of cash flows will remind the market of the margins producers are still making despite the switch in sentiment.

Add to that some volatility during what is unlikely to be a straight line path to normality over the next 12 months and we believe gold stocks have been oversold, with good potential for trading opportunities over the coming months in the gold producers as the markets swing between a risk on / risk off view.

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