I. Sector landscape and outlook

The recent rally in gold mining stocks is expected to continue at least in the near- to mid-term given the overall volatility in the broader market. COVID-19 pandemic, which has infected approximately 4.05 million people around the world and fatalities surged to about 280,000, has induced unprecedented uncertainty amongst the decision-makers at large. Investment avenues ranging from investment grade to non-investment grade or speculative asset classes, all have significantly underperformed, and broader markets have tested a multiyear low. The yield has also dried up the money market with the total value of bonds with a negative bond yield topping $15.6 Trillion.
 

However, this free fall in the speculative asset classes and falling yield income on fixed income securities has brought the safe-haven yellow metal “Gold” into the limelight again. Gold as an asset class has returned decent returns of around 12% (YTD) during COVID-19 outbreak, and we believe it will continue to do so, as central banks across the world are flooding the market with cheap money.

Nevertheless, in March 2020 when the footprint of COVID-19 abruptly expanded in Europe and North America, investors hit the panic button and started liquidating their portfolio, including gold stocks, as many rushed to maintain cash flow. Furthermore, gold prices also fell as many traders were forced to square-off their position due to margin calls. The sell-off in March was followed by a V-shaped recovery in gold prices and  NYSE Arca Gold Bugs Index (HUI) – a basket of the global major gold mining stocks and gold prices are now hovering near September 2011 peak levels of $1,776/oz. 

Fig 1: V-shape recovery in gold prices and HUI, since March 20^th, 2020.
 

 
Source: Refinitiv (Thomson Reuters) 
 
Bullish trend: A bullish price trend appeared on the gold price and HUI chart, as both gold prices and HUI registered a sharp recovery from March 20^th, 2020, and since then gold prices have surged approximately 14% whereas HUI, which gauges a basket of global major gold mining companies has leapt up by ~ 72%. 

We believe gold mining stocks have a long way to go from current price levels. Further, a few gold stocks are relatively undervalued compared to the price of its underlying asset "Gold", but we are likely to see the narrowing of valuation gap between gold stocks and underlying yellow metal price this year.

The best way to gauge the value of gold mining stocks against the yellow metal is the HUI to gold price ratio (Divide one share of NYSE Arca Gold Bugs Index (HUI) by an ounce of gold). Gold last traded at $1,700.64/oz and the HUI at $ 285.28/share; therefore, the ratio is 0.17. In the past ten years, this ratio has ranged from as low as 0.079 in 2016 to as high as 0.41 in 2011. We believe that the ratio can bounce back to its average of 0.20, which implies a further lower double digit expansion in the near to medium term. Let us now gauge the demand for the yellow metal.
 
Gold demand in Q1FY20 held ground
During the first quarter of 2020, gold  witnessed a strong demand at 1,083.8 tonnes and registered a growth of 1% against the same period of the corresponding financial year, according to latest numbers revealed by World Gold Council on April 30^th, 2020. The demand was coming from the ETF’s while traditional demand drivers such as Central Bank buying, and Jewellery witnessed a decline.

Fig 2: Gold - Q1’20 demand
                                                                                                

Source: Gold Hub
 
Fig 3: Gold Demand Trend

Source: World Gold Council
 

1. Gold-backed Exchange Traded Funds (ETFs) saw a massive inflow of 298 tones and pushed global gold holding in these products to an all-time high of 3,185 tonnes. In Q1’20 Gold ETFs witnessed a seven-fold increase (YoY) in demand as investors have rushed to ditch speculative asset classes and swapped to safe-haven gold assets because of the recent bloodbath in the financial market similar to the 2008 financial crisis. On a year-to-date basis (as on April 30^th, 2020), inflows in the UK Gold ETFs surged by 16.3%. 
 

2. Further, the trend continued in April'20 as well, with globally gold-backed ETFs adding inflow of another 170t which helped to push ETFs’ holding to a new all-time high of 3,355t. The global gold-backed ETFs AUM (Asset Under Management) surged to a new all-time high of US$ 184bn. 
 

3. US$ Gold prices hit an eight-year high: A investment glut for gold-backed ETFs helped pushed the US$ Gold price to an eight-year high and demand in value terms surged to $55bn, the highest level since Q2'2013. Further gold prices in Indian rupee and Turkish Lira registered an all-time high.

 
 
Fig 4: Monthly gold-backed ETFs flows

Source: Gold Hub
 

1. British gold-backed ETF funds have consistently grabbed both regional and global market share, and now account for ~ 47% of European assets and 21% of global asset, and on the same lines, low-cost gold-backed ETFs in the US have seen positive flows for 22 of the past 23 months and have increased their collective assets to 91t, which amounts to roughly the holdings of all Asian-based funds. 
 

2. Coronavirus pandemic hit the jewellery demand hard as globally states have imposed lockdowns and restriction on movement for non-essential items. Jewellery demand significantly contracted in China by 65%-the largest jewellery consumer and the first market to succumb to the outbreak. 
 

3. Meanwhile, Federal Banks continued to store gold, however at a slower pace. As given the prevailing market conditions and fog of uncertainties hovering over, globally gold reserves soared by 145t in Q1’20.
 

Having looked at the demand scenario, let us now gauge the cost dynamics of a gold explorer or miner.  
 

Gold miners are benefiting from higher gold prices but will also likely to benefit from lower oil prices. The mining and processing of gold require diesel gas to operate heavy machinery and vehicles to mine and transport gold ore. This is especially true with open-pit mines, where a haul truck or dump truck is required.

Fig 5: Brent Crude Oil Performance.
 

Source: Thomson Reuters

International crude oil benchmark Brent Crude prices have gone down more than US$ 47/bbl on a YoY basis, and we have not seen such correction in crude oil since 1998. Prices were down approximately 56% on an annual basis as on 8 May 2020. Moreover, there is not much seen in terms of recovery as of now, as the OPEC+ supply cuts have done nothing much to stop the free-fall in prices and lockdown announced by many countries is also weighing on oil prices. 

Gold prices are trading above $1,600/oz for a considerable period, and oil prices are down ~ 56% from Q4 2019, so we believe that we might see a higher per ounce margin for most gold miners.

How is the gold price projected in the near term? Let us find out. 

Gold price outlook

The recent demand surge for gold-backed ETFs and price strength of the yellow metal has so far mirrored that of the Sub-prime Crisis of 2008. At that point of time, it kept on edging higher nevertheless initial Quantitative Easing (QE) program in the US, which, along with similar monetary policy interventions worldwide, prompted the yellow metal to appreciate over 130% higher at its peak in September 2011.

Although the economic deceleration has negatively impacted gold demand from jewellery and technology space, history suggests that the likely strength of investment demand may counterbalance this weakness. In conclusion, we expect central banks to remain net buyers of gold in 2020.
 
II. Investment Theme and Stocks under Discussion (CEY, HGM, SRB and SHG)

Having understood the industry dynamics, let’s now look at the four gold miners those are listed on the London Stock Exchange.To assess the same, companies’ stocks are evaluated based on Discounted Cash Flow (DCF).
 
Fig 6: Relative performance of the stocks under discussion against FTSE 100 (YTD)