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Has a gold rush begun?

Tony Featherstone makes the case for gold and outlines three ways to invest in the sector.

Are the gold sector’s recent gains a short-lived reaction to volatility in global equities or the start of a gold rush? The answer will make a huge difference to returns this year.

I became bullish on gold in November 2018, and suggested investors increase their portfolio allocation to gold and cash over the next few months to preserve capital and support returns.

As I wrote in my final column for 2018, I see 2019 as one of transition that provides clarity on four key issues.

Globally, the two key questions are the pace of United States interest-rate rises (and thus the health of the global economy); and the extent of the US/China trade war (and how it affects the slowing of China’s economy and what that means for Australia).

Locally, the two issues are whether Australia’s residential property market has a hard or soft landing (and what that means for consumer spending, or just over half the economy); and regulatory change (from royal commissions) and political change (from elections and policy initiatives).

Many other issues, of course, affect market sentiment. But the four above are whoppers and, taken together, suggest sustained higher volatility in 2019. That’s good for gold.

The pace of US interest-rate rises is critical. Market expectations of rising US interest rates and a rising US dollar weigh on the US-dollar gold price. Recently, the consensus view for US rate hikes this year has fallen from three increases to two. There’s even talk that the US Federal Reserve could pause rate hikes for much of 2019, if the US economy slows faster than expected.

The US/China trade war plays into the US growth, rates and currency conundrum. Apple Inc.’s recent guidance downgrade and share-price tumble was triggered by its comments about sluggish Chinese demand for iPhones. Chinese growth looks to be slowing a little faster than markets expected.

Back home, the property downturn continues apace, judging by auction clearance rates before Christmas and latest price data. The downturn still has a way to run and it will force the Reserve Bank to keep interest rates on hold throughout 2019 or even cut them. That will weigh on the Australian dollar and continue to support a higher Australian-dollar gold price.

Politically, the likelihood of the Coalition being re-elected in 2019 decreases by the day. Labor’s proposed changes to negative gearing and franking credits are a concern among investors. If implemented, these reforms will weigh on the Australian economy, at least in the short term, and add to share market uncertainty. That’s good for gold.

To be clear, I’m not proposing investors dump their equities and load up on gold in anticipation of a boom. Rather, that investors cautiously increase their allocation to gold bullion (5-10% for most) and that speculators keep an eye on gold equities in 2019. Gold bullion and gold equities are rallying and more gains are likely.

Tailwinds for gold will attract inflows into gold exchange-traded funds (ETFs), which in turn will force these ETFs to buy gold equities to maintain their index exposure.

Macquarie Group this week noted VanEck, a global ETF provider, owns about 13% on average of Evolution Mining, Northern Star Resources, Regis Resources, St Barbara and Saracen Mineral Holdings.

Here are three ways to gain gold exposure:

1. Gold bullion ETFs

As noted previously in this Report, investors who want pure exposure to gold should focus on bullion rather than equities. Gold equities have their place, but have equity and market risk in addition to commodity risk. Gold stocks can get caught up in a global equity rout, even if the gold price is rising. Better options for pure gold exposure exist.

The ETFs Physical Gold ETF (GOLD:ASX) is one of them. Bought and sold like a share on the ASX, the ETF rises when the gold price rises (assuming constant currencies) and vice versa.

I nominated the ETF in November for this Report and it has rallied sharply since then.

The ETFs Physical Gold ETF is unhedged for currency movements.  Investors who want to eliminate currency risks should use the BetaShares Gold Bullion ETF (QAU:ASX).

I’m tipping a lower Australian dollar versus the Greenback in 2019 – and a higher Australian-dollar gold price – so I will take on the currency risk with the unhedged ETFS gold ETF (GOLD).

Chart 1: ETFS Physical Gold ETF (GOLD)

Source: nabtrade

2. Gold equity ETFs

Investors seeking diversified exposure to gold stocks should consider the VanEck Vectors Gold Miners ETF (GDX:ASX). It aims to replicate the price and yield performance of an index that includes many of the world’s largest gold producers.

GDX has company, market, commodity and currency risk. But having exposure to 46 mostly larger gold producers across eight countries through the ETF offers far better diversification than owning a few ASX-listed gold producers or explorers directly.

Investors with higher risk tolerance could consider the VanEck Vectors Junior Gold Miners ETF (GDXJ:NYS). Quoted on the New York Stock Exchange, GDXJ provides exposure to 72 mostly small and mid-cap global gold stocks. Several ASX-listed gold stocks are in the ETF’s top 10 holdings.

GDX returned 14% in December, as investors clamoured for gold exposure but is almost flat over one year. The riskier GDXJ ETF lost 2.3% in December (in US dollars).  

GDX is a simple, low-cost, convenient way to gain exposure to a basket of global gold equities. If my base case holds true: the gold price continues to rally, the Australian dollar marginally weakens, and equities markets stay broadly flat in 2019, GDX should have a solid year.

Chart 2: VanEck Vectors Gold Miners ETF

Source: nabtrade

3. Gold equities

Newcrest Mining (NCM:ASX) looks to be trading around fair value after recent price gains and amid challenges over declining grade and ramp-up uncertainties with its Cadia Hill mine. Newcrest is slightly above Morningstar’s fair-value estimate of $23 a share.

I prefer Northern Star Resources (NST:ASX) and Evolution Mining (EVN:ASX), although both look fully valued after soaring share-price gains in 2018. Northern Star has a 60% total return over 12 months and the impressive Evolution Mining delivered 33%.

Chart 3: Evolution Mining

Source: nabtrade

Both companies have strong organic growth profiles, plenty of cash to make acquisitions and good leverage to a rising Australian-dollar gold price. Evolution is trading near Macquarie’s $3.80 price target and Northern Star (currently $9.15) is below the bank’s $10.30 target.

An average price target of $8.25, based on the consensus of 14 broking firms that cover Northern Star, suggests it is overvalued. I will stick with the bulls on Northern Star, given its potential for higher production and a rising gold price.

But valuation risks for Northern, Evolution and other well-performed ASX gold stocks are rapidly rising, strengthening the case for diversified global exposure through a gold equities ETF rather than direct exposure through a few stocks.

Chart 4: Northern Star Resources


About the Author
Tony Featherstone , Switzer Group

Tony is a former managing editor of BRW, Shares, Personal Investor, Asset and CFO magazines and currently an author at Switzer Report. He specialises in small listed companies, IPOs, entrepreneurship and innovation and writes a weekly blog for The Sydney Morning Herald/The Age on small companies and entrepreneurs.