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Could Interest Rate Rise Create Opportunity in Gold Stocks?

Bearish market sentiment for gold has created an opportunity to buy gold miners at attractive prices as equity markets assume a long-term gold price of less than $1,000

Morningstar Equity Analysts 1 December, 2015 | 11:35AM
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Fed rate hike worries have created an opportunity to buy gold miners at a discount. The market is rightly concerned about the impact of higher rates on investor demand for gold. But a narrow focus on investor demand overstates its importance to gold's long-term outlook. The next decade will see a profound shift in gold's nature: from a "financial" commodity to a "consumer" commodity.

The massive investment flows into and out of gold in the past several years temporarily concealed this development, but going forward, consumer spending will be too great to mask any longer. Even in the face of weak investor demand, we forecast a 4.7% CAGR in total physical gold demand over the next five years, led by Chinese and Indian jewellery buyers.

We expect jewellery to account for two thirds of gold demand by 2020, up from a 50% share in the past five years. We see the share of gold purchases by central banks and ETFs dwindling below 5%. Gold supply growth must accelerate, but mine projects in development would be insufficient to meet demand. To avert a shortfall, we estimate an additional 200 tonnes of annual mine supply would be required by 2020, equivalent to about 5% of global mine production.

A prospective supply shortfall is bullish for gold prices, but significant mine cost deflation diminishes the upside. We forecast a gold price of $1,300 per ounce on a nominal basis by 2020, or roughly $1,160 in constant 2015 dollars. Gold miners are cheap. Equity market valuations appear to reflect expectations of sub-$1,000 real gold prices in the long run, well below our long-term forecast. The median gold miner in our coverage trades at a 20% discount to fair value. Barrick Gold (ABX), Eldorado Gold (ELD), and Goldcorp (G) offer the most attractive risk-adjusted discounts to our fair value estimates.

Table of gold mining companies and Morningstar analysts' views

Barrick Gold has historically been one of the worst capital allocators in the sector, but under new leadership, it's embodied the industrywide shift in focus to profitability from production. In addition, the company is working to fix its balance sheet, reducing debt by $3 billion in 2015 alone.

While the newly elected Greek government has attempted to halt Eldorado's development work, Greek court rulings and local community support have kept Eldorado's project moving forward. Market overestimation of the risk in Greece creates an attractive buying opportunity.

With development failures by other gold miners fresh in investors' minds, operational setbacks at Goldcorp's development projects have weighed on its share price. But each of the issues is temporary and none cast significant doubt on the projects' long-term production and cost profile.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Barrick Gold Corp23.60 CAD0.00
Eldorado Gold Corp11.71 CAD0.00

About Author

Morningstar Equity Analysts  Morningstar stock and fund analysts cover 2,000 mutual funds, 2,100 equities, and 300 exchange-traded funds.