Here's why gold stocks can play a valuable role in your portfolio
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Quality gold stocks can play a valuable diversification role in an Australian equity portfolio as investors navigate uncharted global economic conditions.
The outlook for the gold sector is rosier now than it has been in recent years. After jumping in August to a 2-year-plus high, pumped up by the Brexit vote, gold prices have largely held their ground, though prices for Australian miners have held eased slightly.
But some could be worth a look as margins improve, analysts say. Following the gold price up, shares in large Australian gold producers such as Evolution Mining (ASX: EVN), Regis Resources (ASX: RRL), Newcrest Mining (ASX: NCM), Independence Group (ASX: IGO), Northern Star Resources (ASX: NST) and Doray Minerals (ASX: DRM) have jumped this year.
Also, prices for gold ETFs listed on the ASX have surged, though they eased from their July highs.
Gold prices have ranged between US$1200/oz and US$1370/oz since late June, and are up by around 25 per cent as at mid-September from a trough in mid-December.
But with more uncertainty ahead, as the US Federal Reserve prepares to raise interest rates, the gold price could rise further, according to some experts. Gold miners too could add value and diversification to investors' portfolios.
According to Mathew Hodge, sector head of basic materials and energy with Morningstar, the macroeconomic uncertainty has raised the appeal of gold stocks.
"The insurance attributes of gold could come in handy given the current uncharted global economic conditions, notably the headwinds to developed world economic growth and record low interest rates," he said.
"We think gold equity via Newcrest Mining has a valuable diversification role in an Australian equity portfolio."
Newcrest Mining shares are currently trading around $21, down from a recent 52-week high of $27.20, but they are well up from a year low of $10.71.
"Despite the impressive share price run this year, we still think it's one of the best value mining stocks under our Australian coverage. We still see further upside in margins and returns on invested capital," Hodge said.
"We reaffirm our $21 per share fair value estimate. This is based on an unchanged mid-cycle gold price assumption of US$1,163 per ounce.
"Newcrest's competitive position relative to peers is improving thanks to the depreciation of the Australian dollar and the end of the mining boom in Australia.
"The only other stocks with meaningful gold that we cover are Regis Resources and Independence Group--both of which we think are expensive."
According to analysts' forecasts published on FT.com, the 15 analysts offering 12-month price targets for Newcrest Mining as at 12 September 2016 had a median target of $23.99, with a high estimate of $30.00 and a low estimate of $12.27.
Hodge isn't the only analyst noting the upside in gold producers' margins. According to a "Gold in Focus" September 2016 market update from National Australia Bank, gold producers' average cash margins have improved as a result of the ongoing cost management efforts by gold producers since 2013, combined with strong rises in gold prices in the first half of 2016, as the chart below shows.
Chart 1: Average cash margins by producer size
Source: Bloomberg, NAB Group Economics
"Stronger producer margins and historically elevated gold price levels could see a pick-up in gold-related capital investment in the near term," the research note said.
Joe Foster, portfolio manager and strategist at the VanEck International Investors Gold Fund, said any tightening in monetary policy by the US Fed could see the gold price rally.
"We believe any decision to raise rates in 2016 will ultimately be viewed as a misstep that increases financial and economic risks, and this will be to gold's benefit," he said.
Foster believes demand from India and China will support gold, as well as demand from some central banks, which are continuing to boost their gold holdings.
"In the near term, India could lend support to the gold market. Indian gold demand has been very weak this year due mainly to the higher gold price. This suggests there is pent-up demand," Foster said.
"Our June update highlighted a new bull trend in the gold price. The base of that trend is currently around $1,290 per ounce. If this price level holds through September, it would be a further sign of resilience in the gold market."
As Foster notes, another important factor boosting gold prices is increased demand from central banks.
"Against a backdrop of elevated global economic and geopolitical risks--such as a tentative divergence in monetary settings between the US and the rest of the world, continuing conflicts in the Middle East and the recent Brexit vote, many central banks continued to increase their gold holdings in the first half of 2016 as a way to diversify their reserve portfolio," the NAB market update said.
Central bank holdings are now at their highest levels since 2013, the research note said.
So, for those investors holding gold stocks, the times are good and further gains are possible. Wait and watch for the market volatility, which benefits the precious metal.
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Nicki Bourlioufas is a Morningstar contributor.
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