All change: commodity markets are entering a new phase
There will be opportunities for investors as cyclical and structural trends shake up natural-resource markets.
2 Dec 2021
Two key drivers of the gold price – central-bank policy and inflation – are on the move. As the chart below shows, these two influences have combined in various ways to shape the gold market since the early part of this century.
Now, following a coordinated and significant monetary and fiscal response to the pandemic globally, we have passed the point of maximum easing. Central-bank policy is beginning to tighten relative to its pace of easing last year.
At the same time, inflation is proving more persistent than many expected. It continues to surprise to the upside in many regions, with supply bottlenecks and temporary COVID impacts making price rises stickier than previously expected. This has led central banks to further ponder whether stimulus should be withdrawn. Much of the debate in the market centres on how much of the inflation is transitory. Will base effects wash out or will the momentum continue? For investors, it’s worth thinking through the scenarios that might play out from here, and how they could impact gold.
Figure 1: Gold is driven by policy, but this is amplified by inflation
|Policy + inflation -||Policy + inflation +||Policy - inflation +||Policy - inflation -|
Note: ‘Policy – ‘ = tightening policy, ‘inflation – ‘ = low inflation; and vice versa.
Source: Ninety One, Bloomberg, 30 September 2021
Scenario 1: inflation proves transitory
Scenario 2: a structurally higher level of inflation
Of course, central-bank policy and inflation are not the only issues that may influence how gold performs in 2022.
There is also the fact that the path from here for the global economy is extremely uncertain – and gold’s reputation as a safe-haven asset means that, as economic uncertainty increases (typically associated with falling equities), investors tend to allocate to gold. With governments trying to normalise financial conditions and growth prospects diverging internationally, it remains challenging to forecast precisely what issues may arise in 2022. But it seems easier to forecast that there are likely to be issues. In such an environment, gold’s appeal should increase after a dull year for the precious metal, given its usefulness for investors looking to diversify their portfolios.
For investors getting gold exposure through the equities of companies that mine and produce gold, there are other reasons to look forward with a degree of optimism. We think gold-mining stocks are attractive on both valuation and fundamental grounds. In fact, gold companies are in their best shape for nearly 40 years. A number of them are reporting record cashflows and, increasingly, these cashflows are less reliant on a high gold price. The following case studies illustrate some of the opportunities in the gold sector across the market-cap spectrum. For an overview of gold equities, please see the boxed text.
We believe that a number of mid-cap gold companies are emerging with solid foundations and good growth prospects – among which SSR Mining is a great example, in our view.
SSR Mining combines a strong balance-sheet (it has net cash of US$411 million) with various brownfield growth opportunities and exciting exploration ground around all of its operating assets.
Presents shareholders with an opportunity to own a defensively positioned company which is generating cash, and returning it via a dividend and buybacks (with a shareholder return of just under 5% in total currently for 2021). In addition, the company should be able to grow production by around 20-25% in the medium term and has a good chance of replacing – even growing – its reserves over that period.
If gold prices remain where they are, we would expect reasonable returns for SSR Mining’s shareholders, given the company’s free-cashflow yield of around 10% and growth prospects. In the event of a major equity market correction, history suggests that gold and gold equities tend to outperform. Thus, in a very uncertain macro environment, we think investors in SSR Mining are being paid for holding a diversifying asset in their portfolios.
Newcrest Mining is a large-cap Australian gold company producing over 2 million ounces (Moz) per year. Newcrest has had a difficult few years, partly due to operational problems at its two large mines, Cadia in Australia and Lihir in Papua New Guinea.
With its Telfer mine in Western Australia near the end of its life and continued delays at the Wafi Golpu project it is aiming to develop in Papua New Guinea, the company looked unbalanced and undiversified. However, in 2018 and 2019, Newcrest built up a stake in Lundin Gold in Ecuador as Lundin brought on its flagship Fruta Del Norte mine, and acquired 70% of the Red Chris mine operation in Canada. It also took a majority stake in the Havieron deposit discovered by Greatland Gold near its Telfer mine.
By Q3 2021, the company could point to a recovering outlook for Lihir and a more stable plan for Cadia, helped not least by its high copper by-product credits. With pre-feasibility studies released for Havieron, Lihir expansion and Red Chris, it also could showcase a pathway for margin growth over the next eight years, with costs expected to halve due to mine developments.
Newcrest recently announced a planned acquisition of Pretium Resources, which will add around 350,000 ounces per year of gold production in the same region of Canada as Red Chris. One of the most experienced underground mining companies, Newcrest now has a world-class portfolio of assets with among the longest reserve lives in the industry.
Developing these assets will take time, and the market is reluctant to give full value for them as it worries about the short-term issues facing Newcrest. However, we believe that Newcrest’s recent acquisitions, combined with a focus on basic operating procedures, are beginning to revitalise a company with increasing belief in its skills and expertise. As recent acquisitions have appeared well-timed and operational results have improved, the company which had a major strategic problem only three years ago, now looks well-balanced and confident of delivering on its plan.
Addition to offering many of the same investment characteristics as gold – inflation protection and cyclical resilience – gold equities provide complementary qualities to a portfolio.
Investors should also be aware that gold equities provide leverage to the gold price and are typically more volatile than the yellow metal itself. However, the level of sensitivity of gold equities to the price of gold is not over time with factors such as gold miners’ balance sheets and exploration. We therefore favour a selective approach to investing in gold equities, with a focus on businesses with highly capable management teams, a good quality and reasonably diverse portfolio of assets, strong balance sheets, and an intelligent and sensible approach to capital allocation.
Commodity-related investment: Commodity prices can be extremely volatile and significant losses may be made. Equity investment: The value of equities (e.g. shares) and equity-related investments may vary according to company profits and future prospects as well as more general market factors. In the event of a company default (e.g. insolvency), the owners of their equity rank last in terms of any financial payment from that company. Geographic / Sector: Investments may be primarily concentrated in specific countries, geographical regions and/or industry sectors. This may mean that the resulting value may decrease whilst portfolios more broadly invested might grow.
The value of investments, and any income generated from them, can fall as well as rise. Where charges are taken from capital, this may constrain future growth. Past performance is not a reliable indicator of future results. If any currency differs from the investor's home currency, returns may increase or decrease as a result of currency fluctuations. Investment objectives and performance targets are subject to change and may not necessarily be achieved, losses may be made. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.