Stockhead: Shining in darkness - small cap goldies can defy inflation demon

What is not good for the world at large can often be good for the gold price. So amid global turmoil this precious metal has been, well, precious.

The world is in turmoil, but this precious metal is as good as gold. Picture: AFP

What is not good for the world at large can often be good for the gold price.

It is a space the yellow metal found itself in during the March quarter when US dollar prices gained 8% while equity and bond markets were hit hard.

Evolution executive chairman Jake Klein neatly summed up the factors that drove gold prices higher in the group’s recently released quarterly production report, acknowledging at the same time that the factors came with broader regrets for the world.

“At the macro level, this quarter in the US inflation rose 8.5%, its highest level in 41 years while unemployment rates in the US and Australia are at historic lows.’’

“Russia’s invasion of Ukraine is now entering its third month, with the conflict showing no signs of reducing. And COVID continues to wreak havoc on people’s health, workforce availability, and supply chains,’’ Klein said.

“Against this backdrop, gold has been fulfilling its traditional role as the best hedge against inflation and geopolitical uncertainty.

“Regrettably for the world, I expect these issues to continue.’’

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From that it can be taken that Klein (Evolution is the third biggest gold price on the ASX) believes gold’s safe haven properties will continue to shine in 2022 although there are some challenges, as has been reflected in gold’s recent retreat from record levels of more than $US2,000 an ounce.

Despite the retreat from record levels, the current price remains comfortably ahead of the 2021 average of $US1,798 an ounce.

And at an exchange rate of US72-74c, the local gold price continues to deliver fat margins for the gold producers (Evolution’s margin was 60% or $A1,474 an ounce in the March quarter), as well as plenty of incentive for the gold mine developers and explorers.

The main challenge to the gold price in coming months is what the World Gold Council (WGC), the industry’s promotional body, describes as the “opposing forces of inflation and rising rates.’’

Its historical analysis shows that gold typically performs well following the first rate hike in a tightening fiscal cycle. But with central banks about to act on the first of a series of rate rises, the WGC believes gold might come under pressure – something already reflected in gold’s retreat from record levels.

Evolution Mining executive chairman Jake Klein. Picture: Hollie Adams

However, further weakening in the gold price is not a given as rising inflation, lower growth, and falling consumer confidence could well check the pace of interest rate rises, the enemy of physical gold because it is a non-yielding asset class.

While the near-term uncertainty around the gold price pans out, what is more certain is that despite the current gold price remaining at historically high levels, gold equities have been beaten up to a point where opportunities for investors are opening up.

On the assumption that gold holds at current levels, the sell-off could well represent a buying opportunity across the producers, developers and explorers.

Add in the possibility that gold shakes off the coming rate rises to trade higher, the potential upside could be significant.

That’s because gold’s strong price performance in March quarter in response to Russia’s invasion of Ukraine, and the potential for inflation to outpace nominal yields, has prompted higher gold price expectations among analysts.

The Royal Bank of Canada’s equities desk provides a recent example with its analysts increasing their gold price forecasts for 2022 and 2023 by 9% each to $US1,889 and $US1,759 an ounce respectively.

Despite the forecast move lower in 2023, RBC’s overall increase in its gold price desk underpinned an average 21% increase in the price targets for the gold stocks it follows.

“Including our forecast changes, the biggest price target movers (based on April 20 prices) were OceanaGold (OGC, plus 45%), St Barbara (SBM, plus 33%), and Silver Lake (SLR, plus 22%).’’

“For 2023, earnings per share increased by an average of 34%, with SBM (plus 59%), Regis (RRL, plus 44%), and SLR (plus 43%), leading the increases,’’ RBC said.

RBC said it favours gold stocks with greater free cash flow yields, strong balance sheets and good operational records.

“If gold does fall in 2022/23, as we forecast, we would continue to favour stocks with higher and relatively more predictable cash flow. Northern Star (NST) and Regis remain top picks in the large-cap and mid-tier space respectively.’’

Away from the big end of town, near-term gold mine developers like Calidus (CAI) and Red 5 (RED) have performed strongly as first production approaches. Assuming the new mines hit their targets, the rerating could continue.

Two West African gold developer stocks with big gold resource bases, Tietto (TIE) and Predictive (PDI), have yet to catch the re-rate wave but are in line to do so as first production approaches.

Among the explorers, Musgrave (MGV) continues to impress with high-grade gold results at its Cue project in Western Australia while big things are expected from Leonora gold explorer Genesis Minerals (GMD) now that Raleigh Finlayson is on board.

This content first appeared on stockhead.com.au

The views, information, or opinions expressed in these articles do not represent the views of Stockhead. Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in these articles.At Stockhead, we tell it like it is. While some companies mentioned in these articles are Stockhead advertisers, they did not sponsor any of these articles.

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