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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 of 2008. Among the forces that have driven gold to a two-year high this month, however, is not just the UK’s dramatic decision on 23 June to exit the EU. Instead, analysts believe Brexit is merely the latest in a series of macroeconomic events that is 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 JSE, into orbit. AngloGold Ashanti, for instance, was 20% higher within the first hour of trade following on 24 June.
Analysts swivelled back 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 Ashanti, Harmony and Sibanye Gold become seriously cash generative after capital expenditure, creating what is known as free cash flow.
Any investor worth their salt knows that when this happens, a company either spends on growth or returns the cash to shareholders.
Gold price forecasts
On 28 June, 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 29 June 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 [quantitative easing] is required to aid the process.”
QE kept the gold price buoyed in the aftermath of the 2008 financial crisis: when central banks inject more money into the financial system – aimed at retaining confidence – some of that liquidity is diverted into gold. Paradoxically, that is sometimes construed as an expression of no confidence in the financial system.
The outcome is a massive cash boost for the gold firms which, in the case of SA stocks, are doubly helped by the slump in the rand at the end of 2015. Gold firms with 100% exposures to SA, such as Sibanye Gold and DRDGold benefit particularly; so does Harmony Gold which has only one offshore operation.
“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-dollar exchange rate of 15. The fact of the matter is that the gold price was trading at $1 351/oz at the time of writing while the rand was at 14.50 to the dollar.
The outcome in rand terms is a record gold price received by SA gold producers. At the time of writing, they are receiving about R637 000 per kilogram of gold, which is some 37% more than a year ago, or R173 000 more per kilogram of gold produced.
This has put a new spin on analyst warnings at the close of the first quarter of 2016 that perhaps the SA gold bull run would suffer tired legs. According to Mnguni, geographically diversified gold producers with output of over 2m ounces a year could also re-rate. AngloGold was trading at a 37% discount versus its historical discount, he said.
Rebuilding balance sheets
Gold counters have wasted no time in capitalising on the swing in sentiment.
On 7 June, 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 31 December (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.
This is a shortened version of the cover story that originally appeared in the 14 July edition of finweek. Buy and download the magazine here.
