IF there’s one thing that can be said for gold, it’s that it never wastes a good crisis.
The last time bullion was at current levels was during the Global Financial Crisis (GFC) of 2008. The forces that have drove gold to a two-year high earlier this month, however, are not just those related to the UK’s dramatic decision to exit the European Union (EU) on June 23. Instead, analysts believe Brexit is merely the latest in a series of macro-economic events that are describing a new era of global instability.
Within a few hours of the UK polling stations closing the price of gold had rallied 8.5%. It reached a two-year high of $1,358 per ounce and sent gold shares, including those listed on the Johannesburg Stock Exchange, into orbit. AngloGold Ashanti, for instance, was 20% higher within the first hour of trade following on June 24.
Analysts returned to their spreadsheets. Suddenly, and dramatically, there was a real prospect of a sustainable gold price above $1,300/oz – a level where the likes of AngloGold, Harmony and Sibanye Gold become seriously cash generative, even after capital expenditure. Any investor worth her salt knows that when this happens, a company either spends on growth or returns the cash to shareholders.
On June 28, RMB Morgan Stanley analyst, Leroy Mnguni, raised the bank’s gold forecast for 2017 by 13% adding that not only Brexit, but a more benign outlook for interest rates by the US Federal Reserve and subdued US trade data had now created a supportive medium-term backdrop for gold.
Bank of America Merrill Lynch in a report published on June 29 agreed that more was at work behind gold’s rise than Brexit: “Our US economists also now think the Fed will push out its next rate hike to December rather than September. This is another positive for gold”.
Said Mnguni: “The recent Brexit vote creates medium-term politico-economic uncertainty with the outcome likely to depend on how effectively the exit is managed and how much QE [quantitive easing] is required to aid the process,” he said.
QE kept the gold price buoyed in the aftermath of the 2008 GFC: when central banks inject more money into the financial system – aimed at restoring confidence – some of that liquidity is diverted into gold.
The outcome is a massive cash boost for the gold firms which, in the case of South African stocks, has been assisted by the slump in the rand at the end of 2015. Gold firms with 100% exposures to South Africa, such as Sibanye Gold and DRDGold, benefit particularly; so does Harmony Gold which has all but one of its mines in South Africa.
“As a result of Brexit, AngloGold Ashanti could generate an additional $120m in free cash flow in the second half of 2016 while Gold Fields could add an additional $50m in free cash flow,” said ratings agency Moody’s Investor Service in a note.
It based its assumptions on a gold price of $1,300/oz and a rand to the dollar exchange rate of 15. The fact of the matter is that the gold price is trading at $1,324/oz at the time of writing whilst the rand was at 14.30/dollar.
The outcome in rand terms is a record gold price received by South African gold producers. At the time of writing, they are receiving about R615,000 per kilogram of gold which is about a third more per kilogram of gold produced a year ago.
This has put a new spin on analyst warnings at the close of the first quarter of 2016 that perhaps the South African gold bull run would suffer tired legs. According to Mnguni, geographically diversified gold producers with output of over two million ounces a year could also re-rate. AngloGold was trading at a 37% discount versus its historical discount, he said.
Gold counters have wasted no time in capitalising on the swing in sentiment.
On June 7, Gold Fields announced it had refinanced $1.44bn in credit. It now doesn’t have to repay the first tranche of its debt until 2019. “The refinancing is a key milestone in Gold Fields’s balance sheet management and increases the maturity of its debt,” it said. The fact of the matter is that lenders are more relaxed about gold price prospects than in years.
Three weeks later, AngloGold announced it, too, had addressed the balance sheet by cancelling $471m in debt through the early redemption of bonds that had been due in 2020. Based on its cash holdings of some $484m as of December 31 (which are bound to have been boosted since), the group’s net debt was reduced to $1.2bn from $2bn a year ago.
How sage, now, seems the decision by AngloGold shareholders to reject a plan to demerge the company’s South African assets in a transaction that also asked approval for some $2bn worth of shares issue.
The point is that gold shares are back in the black, generating cash, and cutting debt heavily. It also takes them a step closer to resuming dividend payments, according to a report by Goldman Sachs.
“Gold companies are ahead of their industrial counterparts in terms of having repaired their balance sheets: we expect them to hold net cash by end-2017. Given limited growth capex, we expect them to generate an average 10% FCF (free cash flow) yield a year over the next four years,” the bank said.
“As such, we believe they could be on the cusp of ramping up returns, which in turn, could see gold equities outperforming the commodity,” it said, adding that Randgold Resources, a UK-listed gold counter, was its preferred pick. RMB said it preferred DRDGold and Pan African Resources for their yield – dividends – of 7.1% and 4.3% respectively through 2017.
According to Moody’s, the next few months would be “bumpy” for the gold and currency markets. This is good news for AngloGold and Gold Fields, as well as other gold shares, because volatility sends investors to tangible wealth.
But analysts believe the current geopolitical uncertainty has been years in the making and extends beyond the gyrations in British politics where, for instance, every major political party has or is facing a leadership contest.
In a report for Noah Capital, analyst René Hochreiter observed that the Brexit fallout is only just beginning and “could last for years” with further departures from the EU likely; at the very least, there would be more instability, he said.
A global recession similar in scale to the GFC could also be triggered by Brexit with the re-establishment of trade barriers following EU exits likely to reduce growth globally. Other factors including migration fears would see restrictions on the movement of labour; there would be increasing corporate costs, reducing earnings growth with the net effect of putting pressure on global stock markets.
Hochreiter estimated that a rand gold price of – astonishingly – R1m per kilogram produced was possible for South African gold firms in the foreseeable future following its all-time intraday high of R656,702/kg on June 28, equal to R20,425 per ounce of gold.
But to what extent are we caught in a fresh wave of hysteria?
According to Bank of America Merrill Lynch, world economic growth has been “anaemic for years”, and that the world is caught in a “new era of uncertainty”. What’s perhaps more important about this view is that it was written on June 17 before the British went to the poles on their EU predilections.
“While the underlying ills are nuanced between countries, an increasing polarisation of politics and rise in populism have been common by-products; to that point, wealth generation and distribution, immigration and sovereignity have caused contentious debates.
“Of course, this has not helped confidence and did not make it easier for governments to implement measures necessary for putting economies on a more sustainable footing. As a result, a host of countries have moved through a series of mini-crisis in recent years,” the bank said.
“This dynamic has also tied the hands of central banks and persistently loose monetary policies have, through various transmission channels, been supportive of gold. As such, even if the UK remains part of the EU and gold corrects, we believe prices below $1,200/oz would be a buying opportunity,” it said.
The likelihood of central banks jumping with both feet into gold is serious news as they tend to buy lots of the metal, and hold it; they are not the so-called ‘hot money’ that is chasing short-term returns.
According to the World Gold Council (WGC), central banks added 566 tonnes of gold worth $21bn in 2015 which represented the sixth consecutive year of net purchases. “During the first quarter of 2016, central banks bought 109 tonnes, and we expect total net purchases to range between 400 and 600 tonnes for 2016 as a whole,” the WGC said.
“We believe that the prolonged environment of low or, in many cases, negative interest rates will likely result in structurally higher demand for gold from central banks,” it added.
The gold price is $230/oz stronger this year alone and there’s still evident enthusiasm among investors with gold falling into ‘stronger hands’, said UBS analyst, Joni Teves, in a recent report.
DURING THE FIRST QUARTER OF 2016, CENTRAL BANKS BOUGHT 109 TONNES, AND WE EXPECT TOTAL NET PURCHASES TO RANGE BETWEEN 400 AND 600 TONNES FOR 2016 AS A WHOLE
“The view that the bear market is now over and gold has now entered the early stages of the next bull run is becoming a common theme among our conversations with various market participants,” said Teves. The gold price was at least $230/oz stronger this year and there was still enthusiasm among investors with ‘stronger hands’ for the metal. UBS also believed $1,200/oz was a buying opportunity.
Negative or low interest rate environments, macro risks and deteriorating confidence towards central banks and monetary policy are the reasons cited for the fresh interest. As a result, investors believe a gold price of $1,400/oz is possible with the floor set around $1,190 or $1,200/oz.
“The combination of stronger hands and broader interest has resulted in considerable support on the downside,” she said. Investors were holding gold as a diversification tool rather than chasing the metal or looking for short term price gains.
ETFs BACK IN VOGUE
For the man-in-the-street, buying individual gold shares can be risky business, even though analysts are suggesting that it’s hard to miss on your equities given the universal benefit of a much higher gold price in the future.
That’s sometimes why exchange traded funds are the preferred retail option because investors have access to the metal’s relationship with the world of risk, without the red tape and cost of storage fees of actually owning the metal, or the risk of being exposed to gold company management mistakes which is the usual gambit one undertakes why buying shares.
The WGC recently noted a renewed interest in gold with increases in exchange traded funds forecast. “Gold ETF holdings have also been increasing sharply, a trend we expect to see accelerate as both retail and institutional investors re-allocate funds to gold,” it said.
According to Johann Steyn, an analyst for Citi, bullion ETF holdings have been climbing steadily and in a report dated June 24 had risen to 1,900 tonnes – the first time since the second half of 2013.
“Though the current composition of gold ETF investors is more balanced today between long-term holder and short-term return-chasers versus 2011/12, we expect more of the retail and institutional ‘hot money’ to garner exposure, leading to further ETF inflows,” he said. “As such, we note bullion ETF inflows to tend to be sticky with repect to underlying gold price movements.”
The Financial Times described the Brexit vote as the biggest jolt to the European financial system since the fall of the Berlin Wall, but according to Olé Hansen, head of commodity strategy at Saxo Bank, there’s no need to fear a sudden correction in the metal.
“Gold has rallied by 25% and silver by 30% so far this year,” he said. “While such impressive performances could easily deter investors from getting involved, there are no compelling reasons to expect a major correction from here.
“Just as with oil, the biggest risk to gold comes from extensive positioning. Since May, demand for exchange-traded products backed by physical gold has been rising on an almost daily basis while hedge funds following a one third reduction in May have returned as strong buyers during the first two weeks of June.
“With the fundamental support growing following the Brexit, any retracement should be met by increased investor allocation into the yellow metal,” added Hansen.
Courtesy: David McKay
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