The gold price rallied last week amid a correction in the U.S. dollar, but a key question is whether the dollar will continue to fall. Craig Erlam of OANDA said in an email that he believes the dollar is in a temporary correction, although a decline below 90 in the dollar index could suggest something more exciting for bulls in gold stocks.
Whatever happens to the gold price, gold stocks may serve as an additional hedge against macroeconomic uncertainties. JPMorgan analysts Tyler Langton and Michael Glick initiated coverage of North American gold miners, and they see attractive upside in the sector.
What’s Next for Gold Prices?
Strong gold prices are one excellent reason to own gold stocks. At the very least, it looks like the yellow metal will hold steady for now and increase in price when inflation arrives. Gold stocks offer an alternative way to get exposure to the metal.
The JPMorgan team said real yields and central bank balance sheets support gold prices. They estimate a gold price of about $1,900 an ounce between 2021 and 2024 and a long-term price of $1,600 an ounce starting in 2025.
Langton and Glick think their 2025 estimate is conservative, and they say real interest rates should support the gold price by remaining lower for longer. Further, Covid-19 stimulus measures continue to expand central bank balance sheets. They note that after the Global Financial Crisis in 2008 and 2009, gold prices didn’t peak until the second half of 2011, and they stayed elevated through 2012.
Key Gold Price Drivers
The JPMorgan team believes demand is the main gold price driver, and interest rates influence investors’ appetite for gold. They think supply is less of a factor in driving gold prices because of the sizable above-ground stock of the yellow metal. Unlike other metals, almost every ounce of gold that has been mined is in above-ground stocks in a variety of forms like bars, jewelry and coins. At the end of 2019, the above-ground stock amounted to about 194,500 tons or 56 years of current mine production.
Interest rates dictate the attractiveness of owning gold. Langton and Glick note that the opportunity cost of owning risk-free but yield-less gold increases with higher interest rates and decreases with lower interest rates. That means there is an inverse relationship between government bond yields and the gold price.
The JPMorgan team explained that real yields offer the best proxy for the opportunity cost because including expected inflation provides a better representation of the true yield an investor is giving up by owning gold. If yields start to rise, the gold price and gold stocks could begin to decline.
Other Indicators
Langton and Glick also note that the strength of the dollar can affect the attractiveness of gold. When the dollar strengthens, the gold price becomes more expensive in other currencies, possibly weakening the demand for gold. On the other hand, if the dollar weakens, the gold price in dollars becomes cheaper in other currencies.
While Erlam said a decline below 90 for the dollar index is needed for better support of gold prices, JPMorgan predicts that the index will hold above 90 while gold prices average a higher $1,900 an ounce. The firm sees the dollar index at 90.90 next month, 90.60 in June and 90.80 in September.
Langton and Glick also pointed out that exchange-traded funds have been a source of demand for gold. Before gold ETFs, it was difficult for investors to own gold due to storage and acquisition costs, so many invested in gold stocks to get exposure to the metal instead of buying it outright. The JPMorgan team added that the level of ETF holdings has climbed dramatically over the last 20 years and has been largely correlated with the gold price.
For Now, Gold Is in Good Shape
The JPMorgan team sees the gold industry as being in good shape, with most gold miners in a net cash position ready to generate significant amounts of free cash flow. They estimate that the companies in their coverage list generate cumulative free cash flow from 2021 to 2025 amounting to 52% of their current market capitalization on average.
Due to the experience of past cycles, Langton and Glick expect gold miners to remain disciplined with their mergers and acquisitions. They look for miners to focus most of their free cash flow on internal growth projects and shareholder returns. The JPMorgan team estimates an average dividend yield of 1.8% for the group with room for growth.
The biggest risk they see for the industry is from governments raising taxes to offset the pressures caused by the pandemic. However, Langton and Glick add that those same pressures could cause governments to become more supportive of new projects that generate taxes, create jobs and support communities.
Although the JPMorgan team thinks interest rates will support gold prices in the long term, they aren’t looking for gold beta. Rather, they prefer gold miners with steady production profiles, more brownfield instead of greenfield growth opportunities, and a track record of managing geopolitical risk. They also like companies that can boost their shareholder returns.
The Best-Positioned Gold Stocks
Langton and Glick are especially bullish on Kinross Gold Corporation (NYSE:KGC), which they rate at “overweight.” They believe the company’s discount to the rest of the group and its historical multiple should narrow as the market becomes more confident in its ability to maintain an average annual production of 2.5 million ounces through the end of the decade.
The JPMorgan team also rates Newmont Corporation (NYSE:NEM) at “overweight” for its sold production and declining cost profile. They expect these factors to enable the company to generate strong free cash flow to support internal growth projects and increase its dividend.
Langton and Glick are also “overweight” on SSR Mining Inc (NASDAQ:SSRM). They believe SSR’s discount to the rest of the group will narrow as the market becomes more confident that the company can execute on its preliminary economic assessment at Copler and increase its reserves and production at Marigold.
The JPMorgan team rates Kirkland Lake Gold Ltd. (NYSE:KL) as “Underweight” because they think it has the least upside to their price target compared to the rest of their coverage universe. They also believe the company could see production declines if its growth projects don’t move forward or reserves aren’t replaced.
On the date of publication, Michelle Jones did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Michelle Jones is editor-in-chief for ValueWalk.com and has been with the site since 2012. Previously, she was a television news producer for eight years. She produced the morning news programs for the NBC affiliates in Evansville, Indiana and Huntsville, Alabama and spent a short time at the CBS affiliate in Huntsville. She has experience as a writer and public relations expert for a wide variety of businesses. Email her at Mjones@valuewalk.com.
