Gold stocks to shine in COVID gloom

ABSENT mine closures forced by COVID-19, the ASX-listed gold sector is set up for record profitability in the next couple of years. By Barry FitzGerald.
Gold stocks to shine in COVID gloom Gold stocks to shine in COVID gloom Gold stocks to shine in COVID gloom Gold stocks to shine in COVID gloom Gold stocks to shine in COVID gloom

Australian gold producers are set to rake in the cash. Image: iStock/tiero

Barry FitzGerald

In a broader equities market where growth in earnings of any sort will be cherished in a COVID-19 ravaged world, it is remarkable stuff.

It is of course not de rigueur for the industry to crow about its rosy outlook as its rosiness very much depends on gold mines across the country remaining virus-free and being able to continue to operate.

There is a whole bunch of challenges and additional costs in ensuring that mines are not caught in the nation's lockdown.

And then there is the need to ensure survival in a mine closure scenario by bolstering already (mainly) pristine balance sheets in all sorts of ways - rolling hedges forward, drawing on available credit lines, halting exploration, deferring dividends and so on.

So there is lots of uncertainty at play.

But remove the potential for COVID-19 to force mine closures, and it can be said that the earnings outlook for the Aussie gold miners is as sweet as could be hoped for in the next couple of years (the limit of sensibly guessing the gold price).

It's all due to the dream combination of a rising US dollar gold price, the fall in the US exchange rate, massively lower oil prices, increasing production, and the increased local ownership of mines previously foreign owned.

It is an outlook that has dawned on the share market in recent days, with gold equities aggressively recapturing much of the ground lost since the twin hits in March of diving equity markets, and the liquidity stress-induced selling of gold.

The US gold price has now risen from a low of US$1450/oz on March 20 to $1680/oz earlier this week. At a 61c exchange rate compared with last year's average of 69c, the local price has again be toying with A$2700/oz.

But increased volatility is the order of the day, with gold now swinging up and down on daily reads of how the fight against COVID-19 is going in the US.

Volatility in Aussie gold equities has nevertheless developed a distinct upwards bias in recent days, reflecting an oversold position and a growing recognition of the strength of the sector's latent earnings growth, assuming no serious virus impacts.

The strength of the sector's earnings outlook comes through in a breakdown of the 2020 versus 2021 profit expectations of Goldman Sachs for eight of the biggest gold producers (Newcrest, Evolution, Northern Star, Regis, St Barbara, Saracen, Resolute (overseas production) and OceanaGold (overseas).

Annual profit for the golden eight surges from A$2.64 billion in 2020 (converting US reported earnings at an exchange rate of US61c) to A$4.28 billion in 2021 (using Goldman Sachs' exchange rate forecast of US66c and its $1800/oz gold price expectation).

It is an expected gain for the gang of eight of A$1.64 billion, or 62%.

Goldman Sachs' US$1800/oz gold forecast is a 13% increase on its previous 2021 forecast of $1600/oz, with the increase prompted by risks to global growth surrounding COVID-19, together with a continued savings glut, depressed real rates, and an increased focus on the US election.

 "We think the Australian gold sector is well-positioned to capitalise on healthy margins, strong balance sheets, and a favourable outlook for a resilient or rising gold price," Goldman Sachs said in its April 3 research note.

It said the sector was trading at 0.8x NAV versus 1.1x at the start of the year, and on an average EV/EBITDA multiple of 5x compared with 6-7x since 2007 and a recent peak of about 8x.

As suggested earlier, the earnings growth profile is one that few, if any, other sector will be able to match, even if Goldman Sachs' call on $1800 gold (A$2727 at its US66c exchange rate) is at the upper end of analyst expectations for the metal in 2021.

In comparison, Macquarie has gold rising from US$1522/oz in the 2020FY to $1713/oz in the 2021FY. It is lower than Goldman Sachs but its 59c exchange rate expectation makes for a higher Aussie price expectation of A$2903/oz.

It would normally be expected that the record earnings capability of the gold companies could be translated in to bumper dividend flows, again distinguishing the sector from the broader market and attracting generalist investors looking for yield.

But such is the uncertainty created by the potential for COVID-19 outbreaks to force the closure of affected mining operations, bumper dividend expectations is not currently part of the deal between the sector and investors.

In fact, most of the gold companies are expected to either cut or defer their dividends in the coming June year reporting period, as well as the for first (December) half of the new financial year.

The June year dividend decisions will be made by mining company boards in August. Hopefully by then there will be more certainty around COVID-19 being under control, diminishing the likelihood of mine closures, and rewriting dividend expectations in the process.

Having said that, investment in gold stocks is not driven by the yield story. It's about leveraged exposure to the gold price with its haven credentials. On that score, the strong earnings outlook for the gold producers is expected to be translated in to strong share price performance in the next couple of years.

That means total returns could be well ahead of what the rest of the mining sector can offer.

No guarantees in any of that of course. But at least gold equities are offering up a glimmer of hope in an otherwise dark and gloomy investment world.