Four gold plays to follow

Under the Radar’s advocacy of including gold stocks in our subscribers’ portfolios is paying off handsomely.

Our Aussie gold producing favourites have returned 62% since we went positive on gold some 15 months ago, most recently aided by a gold price that has climbed 7% in four months in US$ and 18% in $A terms. Can the golden run continue? Is it time to take profits? Is there value in the sector? We answer these questions and more.

A break-out to US$1,400 an ounce, but can it go further?

A confluence of events has propelled gold out of its five year trading range of trading largely between US$1,200 and US$1,300 an ounce. But at over US$1,400 an ounce, can it keep going and exceed its US$1,900 an ounce high in late 2011?

Nobody knows the answer to this question because gold’s price is not driven by fundamentals, but momentum can be an investor’s friend. Gold can confound predictions because the vast majority of the substance is unproductive, mainly being used as a store of value. Under the Radar Report wrote in April about how positive we were about the metal, even though the price action was not positive. Fast forward to today and gold has spiked close to 8% to trade at over US$1,400 an ounce, being driven by four main factors, which show no signs of abating and momentum is often an investors’ friend. The four factors are:

1. A marked change in language from the US Federal Reserve, from one where interest rate rises were expected to one where cuts are now being anticipated;
2. An escalation of the trade war between the US and China;
3. Elevated geopolitical risk – whether it’s with the bellicose policy of the US regarding Iran; protests in Hong Kong; Brexit realities.
4. Specific to Australian producers has been the depreciation of the A$ against the US$, as investors have been buying the latter in times of uncertainty, which causes an appreciation of the A$ gold price.

Single mine asset producers are struggling

What has been interesting is that while the large Australian diversified miners have largely benefited from all this, there has been a marked deterioration in the prices of single-asset gold stories in past three months, whose stocks have fallen between 40% and 80%. We’re talking about gold miners like Gascoyne Resources (GCY:ASX), Blackham Resources (BLK:ASX), Dacian Gold (DCN:ASX), St Barbara Mines (SBM:ASX) and Millennium Mines (MQY:ASX).

“Anything carrying extra technical risk, or a project … that looks in any way marginal is being heavily discounted as the market applies an extra risk premium or assumes there is no margin for error should anything go wrong,” industry analyst David Coates of Bell Potter tells Under the Radar Report.

The big diversifieds are the big winners

These big diversifieds have different risk factors, but overall, they have gone from being fairly priced to expensive at the gold price three months ago, to being fairly priced to expensive at the current gold price. There is a definite case for profit taking in the case of Northern Star Resources (NST:ASX) and Evolution Mining (EVN:ASX) – see our notes below.

The S&P/ASX All Ordinaries Australian Gold Index (XGD) – shown in the chart below - has been driven by these stocks and has appreciated below 2,000 points in late 2014 to shooting well over 7000 points in the past month and heading towards 8000; an increase of close to four-fold in four and a half years.

Source: nabtrade

There is value at the smaller end

The single asset producers have dragged on the index, which indicates just how hard the big diversified producers have run (NST is Under the Radar’s best performing stock), but also that there is better value at the smaller end.

Even though there is this more risk in these single asset producers, this is where the potential lies. We’re not saying that conditions are like they were back when we first tipped Northern Star in 2012, nor even in early 2015 when we first tipped Evolution Mining. But the best risk reward propositions for those who believe in a gold price that will keep climbing lie in this space. Coates recommends subscribers have a look at Pantoro Limited (PNR:ASX), which we profile below as one single asset producer with some risk, but also, arguably even bigger potential.

1. Pantoro Limited

Pantoro’s shares got hit about 20% on a quarterly production update that was well below what the market expected, although the stock has rallied from its recent low of 14.5 cents. The company sold just below 10k ounces of gold for the three months to 30 June, which was below the 15k anticipated and does not demonstrate that Pantoro’s Halls Creek Project in the Kimberley region in North Western Australia is producing at the expected run-rate of 80k ounces a year.

The result was even below the third quarter’s result of over 11k ounces, which the company attributed to “underground loader availability during May and June at the Nicolsons mine. As well, the company said that its other underground mine, Wagtail, experienced “complex” ore zones from weathering near the surface, which is a similar issue to what occurred at Nicolsons.

The key take-outs from the announcement are:

• This is one of the risks we focused on as a “one asset producing” mining company;
• There isn’t a fatal floor in our investment thesis because the grades remain good, hence there is no reason to believe that it can’t achieve the 80k ounce run-rate the company has predicted;
• The company is probably a quarter behind the achievement of this run-rate;
• And there is no debt mill-stone around the company’s neck, rather it has adequate cash reserves.

Radar Rating: While we are disappointed with this announcement, we continue to believe the long-term story that this is a small cap gold miner with a growing production profile. SPEC BUY.

2. Northern Star Resources

If Evolution’s CEO Jake Klein represents the current zeitgeist in gold mining, Northern Star’s equivalent Bill Beament is old school. Beament was previously an underground mining engineer who worked for Barminco and brings all those skills and more to Northern Star, which has enabled him and his team to extract more from mines than many experienced analysts thought was ever possible. He’s aggressive in pursuing new projects to say the least. Under the Radar has been a big beneficiary of that philosophy, although we admit that we took profits too early, but tell us anyone who predicted that NST would make a game changing acquisition in Alaska?

Can Beament keep running hard enough to satisfy the voracious appetite of investors. No matter how well you do, there are investors who got in at elevated prices and want more. Many NST watchers are eagerly anticipating the upcoming fourth quarterly report, due later this month. Concerns relate to costs at its Pogo mine in Alaska, where the company is due to release a maiden Reserve in August. The company has make big purchases of newer and bigger equipment in the belief that it will extract more out of this mine.

Radar Rating: The shares have climbed 85% in the past 12 months, which is phenomenal, having announced the Pogo acquisition last August. The company has to sell a lot of gold this quarter to make guidance. There have also been rumours NST is plotting to buy into the super pit in Kalgoorlie. It is by far the most expensive gold stock in our universe (or any universe for that matter). TAKE PROFITS.

3. Evolution Mining

It’s a brave investor to step in front of the Evolution team, led by the ex-Macquarie Banker Jake Klein, whose philosophy very much fits the zeitgeist of not paying up for mines and creating a big portfolio that delivers no matter where we are in the cycle. This style suits investors who are risk averse, and it has worked a treat, having returned 44% in the past 15 months for subscribers and more than six-fold since we first recommended the stock back in late 2014.

But what does one pay for such a stock? Is it worth just holding on because the gold cycle seems to be turning as we’ve discussed earlier in this issue. For one thing, expensive stocks like Evolution are very sensitive to the gold price. What goes up, can come down, no matter how diversified the portfolio.

Certainly, it’s quarterly report this week indicates that costs should remain flat at close to A$900 an ounce, which means that at the current gold price of over A$2,000 will continue to boost its bottom line. This is one reason Evolution remains one of our preferred exposures to the gold sector. The company is expected to deliver a four cents per share final dividend, but this could well be higher.

Radar Rating: Expectations also play a role. The company has provided three year production guidance, anticipating over 750k ounces a year, which shows confidence. Of all the big gold stocks we are not betting against this one, which is heading towards $5 as gold maintains its strength. HOLD.

4. OceanaGold

When you look at our table of price to book, it’s clear that OceanaGold is materially less expensive than the diversified producers Northern Star (NST) and Evolution Mining (EVN). In the case of the former it trades at under a third of its value. This is probably too much, but Oceana does deserve a big discount because of the huge amounts of sovereign risk involved in its portfolio of assets.

The company’s Didipio mine in the Philippines is under constant threat of closure; its New Zealand mines are boxed in; while its Haile mine in South Carolina has experienced problems with culture and a lack of experience.

The sovereign risk was compounded when OGC produced its first quarter result (to 31 March 2019) which was the weakest since 2015. Now there is a real risk to earnings.

Although production and earnings are expected to improve over the rest of 2019, a key factor in all this is the Haile mine, where management is going hard to get costs down, but is having problems with materials handling.

Radar Rating: Haile is the key to this stock in the short and long-term. We are backing off our positive recommendation until we can see costs coming down. HOLD.

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