Gold Demand and Supply  

The modern gold market reflects diversity and growth. The volume of gold produced has increased significantly every year. Gold’s usage spans from jewellery to a hedging tool by Central banks and investors. Regarding the demand, gold jewellery accounts for around 50% of total demand. Approximately 3,479 tonnes (t) of gold was produced in 2019, while the global demand stood at 4,368 tonnes. The average annual gold price was US$ 1,393/Oz in 2019.  As on 20 July 2020 (before the market close at 10.50 AM GMT+1), LBMA (London Bullion Market Association) gold price was trading US$ 1,812.00 per oz (ounce). It is noteworthy that the gold price has increased approximately six-fold since 2001, while the global investment demand has grown by an average of 14% annually over the same period.

The chart below shows the performance of LBMA gold price over the past 3 years, which closed at US$ 1,807.35 per oz on 17 July 2020, reflecting ~44 percent growth over the last 3 years.


 (Source: World Gold Council)

Snapshot of Gold Supply and Demand in Q1 2020 (ended 31 March 2020)



 Global Gold Supply in Q1 2020 (ended 31 March 2020) from last 5 years 


(Source: World Gold Council)

Global Gold Demand in Q1 2020 (ended 31 March 2020) from last 5 years 


(Source: World Gold Council)

Gold had a remarkable performance in H1 2020 as the LBMA Gold Price PM was trading nearly at US$ 1,770/oz by the end of June, the level, which was not seen since 2012. Lately, in the month of July 2020, it has breached the threshold level of US$ 1,800/oz. It was mainly driven as investors have embraced gold as a key portfolio hedging strategy during unprecedented times as we are facing currently due to Covid-19 mayhem. Adjacently in 2020, IMF is currently projecting a contraction of 4.9% in global growth. Moreover, the hopes of swift V-shaped economic recovery are fading due to the resurgence of Covid-19 cases. Against the market backdrop, the gold has outperformed all the major assets in H1 2020.

Different Asset Class Performance for 1H 2020


(Source: Bloomberg, ICE Benchmark Administration, World Gold Council)

Gold has outperformed most assets in a longer run

The picture below shows the average annual return of key global assets class (as of 31 December 2019)


 (Source: Bloomberg, World Gold Council)

COVID-19 outbreak lifted the investment demand of gold and simultaneously impacted the gold supply

The Gold demand surged slightly during the first quarter of 2020 to 1,083.8t, representing 1% year on year change. However, when the coronavirus outbreak started hampering the economic activities, Gold started to emerge as a safe-haven investment. Subsequently, Gold-backed ETFs allured huge inflows, which propelled the global holdings in these products to an all-time high of 3,185t. Meanwhile, the Central banks continued to buy Gold in considerable quantities, albeit at a slower rate as compared to the Q1 2019 data. On the flip side, the lethal virus also caused disruption to gold supply, which thrust the mine production to five years low to 795.8t, reflecting a 3% decline year on year (y-o-y). It is noteworthy that, central bank net purchases totalled 39.8t in May.

Macro-Economic Developments
 

1. Monetary Policy: Reduced opportunity cost of holding gold with persistently low-interest rates bolstered the demand for Gold being a source for long-term returns. 

2. Market Access: Gold-backed ETFs has materially reduced the total cost of ownership and increased efficiency, which has significantly boosted the interest in gold as a strategic investment.

3. Market Risk: Uncertainties arising from US-China trade tension and Brexit, followed by dented economic indicators after Covid-19 outbreak, has further encouraged investors to reconsider gold as a traditional hedging tool in times of turmoil. Moreover, the economic downturn has devalued the Forex market, which is compelling investors to switch to more tangible metal resources.

4. Central Bank Demand: Higher allocation of fold for safety and diversification of reserves portfolio by central banks has uplifted the sentiments of other investors too.

5. Emerging Market Growth: Economic expansion, especially in India and China, has further increased the Gold’s investor base. 
 

Acting as an Indispensable Reserve Asset for Central Banks

Central banks must serve in accord with three guiding principles: liquidity, safety, and return. Moreover, they are supposed to ensure both financial system liquidity and currency stability by deploying their reserves. The robust return of gold by 10.91% from 1 January to 17 April 2020 has attracted the attention of central banks too for a higher allocation towards total reserve portfolio.

Challenges – Supply Chain Disruption Amid Coronavirus Pandemic 

The global dispersion brings stability to the Gold market. However, the onset and scale of coronavirus pandemic have caused unprecedented disruption to the supply chain. The global gold production dipped 3% (y-o-y) in Q1 2020, while the recycling activity plunged 4% (y-o-y). Moreover, small scale refineries and fabricators also halted their operations during Q1 2020. The flow of gold along the chain was further hampered by the stringent travel restrictions across the globe.

Conclusion

Gold was hovering around 9-year highs and was trading at USD 1,812.00 per ounce (as on 20 July 2020, before the market close at 7:00 AM EST). We believe that the upside momentum of gold price in the short-term is expected to continue with the weakening of the US dollar. Moreover, the resurgence of coronavirus cases denting equity market sentiments with speculations regarding another round of lockdown, which would eventually attract more investors towards the gold, as a safe-haven investment. Furthermore, there are several factors which can keep the gold demand intact in the short-term, such as persistently lower interest rate regime, higher allocation of Central banks for diversification, and uncertainties regarding the Brexit and US-China trade tensions. Hence, we can expect a rally in bullion to continue due to weakening US Dollar (boosting purchasing power) and macro-economic uncertainties amid the escalating Covid-19 cases.

The increasing wealth in the East and increasing adoption of gold within the investment portfolio have substantially changed the perceptions of gold. It can act as a genuine diversifier tool in an investment portfolio for a long-term due to the attributes pertinent to scarcity, highly liquid and uncorrelated asset nature. Hence, gold has been proven over time that beyond merely a safe-haven asset during the high-risk time, it can also be an asset to outperform and generate positive returns too. Such dynamics are likely to persist amidst high political and economic uncertainty, battered stock and bond markets, and historically lower interest rates scenario.

Moreover, the structure of the gold market is going through an unparalleled wave of change, which is arising from various aspects, such as demand patterns, regulatory changes, innovation, and the entrance of new participants.
 

1. West to East shift: China and India combinedly capture over half of the global gold demand now, which reflects the shift in demand profile towards the East. Moreover, China continues to play as a predominant player being the largest consumer and producer nation.

2. Regulatory change: The difference in regulation and implementation by region imposes varied costs on market participants and causing an unintended reduction in market liquidity. It can take a few years for gold market regulations to stabilize.

3. Exchange trading: Partially with regulatory changes, there is a shift in asset classes from OTC to transparent trading on the exchange. Even the World Gold Council is planning to partner with players like the London Metal Exchange.

4. New participants: Beside banks, the increasing interest of retail investors through ETFs can also influence the gold market performance in the near term.

5. New technologies: The advent of blockchain technology can also induce a cost-efficient mechanism for facilitating gold transactions.
 

Furthermore, there are several factors which can evolve the gold market in the future, such as the broader economic growth and booming middle-class population in China and India can significantly impact the future gold demand. Also, the advent of mobile applications for gold investments is expected to increase the proportion of retail investors into the market. Meanwhile, environmental, social and governance (ESG) issues can massively influence and re-shape the mining production methods.
 
After having a basic understanding about the gold industry landscape, we will analyse one prominent FTSE listed gold player, Highland Gold Mining (HGM), which has shown a significant growth trajectory and future business prospects looks encouraging from a long-term investment perspective.
 
Highland Gold Mining Ltd (LON: HGM) – Reiterated the Production Guidance to Build Strong Growth Profile with Industry-Leading Margins and Dividends

Highland Gold Mining Ltd is a FTSE AIM 100 Index listed Gold producer, which is engaged in building a portfolio of gold mining operations within Kyrgyzstan and the Russian Federation. The Company’s reportable segment are: Gold production of Khabarovsk region, which comprises of two operating segments, namely Mnogovershinnoye (MNV) and Belaya Gora; Gold production of Chukotka region, which produces Gold & Silver and perform exploration work; Polymetallic concentrate production, namely Novoshirokinskoye; Development & exploration and related services (Zabaykalzolotoproyekt and BSC); Other. The Company was incorporated on 23 May 2002 in Jersey for the purpose of acquiring, developing, and consolidating the portfolio of Gold Mining projects with growth potential in the Russian Federation. In 2019, the overall output of four mines - MNV, Belaya Gora, Novo, and Valunisty - totalled 300,704 oz (ounce) of Gold and Gold equivalent.

On 1 September 2020, the Company is expected to announce the half-yearly results for FY20.

(Source: Presentation, Company Website)

Key Fundamental Statistics



Growth Prospects and Risk Assessment

The Company has been unlocking value for shareholders by maintaining a low-cost position in the industry, delivering relentless growth in production and progressive dividends over the years. The Group has substantial liquidity to pursue future opportunities. Also, the gold production at Kekura will commence in 2023, which can produce 172,000 oz of gold annually at estimated cash costs of US$511 per ounce. Moreover, the integration of Valunisty acquisition has been supporting sales growth further.

 
 (Source: Presentation, Company Website)

The Company is not facing any material disruption in supply chain due to the remote location of mines. Moreover, it is investing in expansion projects, which would enhance production rates. The Company is looking to maximise portfolio output by deploying cost minimising programs consistently. It has a sizeable asset base to cater to a diverse customer portfolio at a competitive cost as compared to the peers. 

However, the performance of the Company is dependent on the production, which may be delayed due to the Covid-19 outbreak. Moreover, the delay in the delivery of material and equipment can lead to a higher cost of production. Also, the business requires adequate resources to maintain future operations and replace depleted mines. Change in the interest rates can cause liquidity risk as well. Further, there is a risk to business operations with the adoption of new laws, regulations, and taxes. Moreover, the volatile demand and supply conditions can adversely impact the commodity prices, and thus, the Group’s profitability. 

Segment Analysis

The Company has five reportable segments as it splits the business units based on the nature of activities and geography. The revenue breakdown by segments is given below:


(Source: Presentation, Company Website)

Synopsis of Recent Developments  

9 July 2020: The Company affirmed the guidance regarding FY20 for production of 290,000-300,000 oz of Gold and Gold equivalent. The average realised Gold price was US$ 1,655 in H1 FY20, while the total production stood at 125,347 oz of Gold and Gold equivalent in the same period.

2 June 2020: The Company announced the sale of the Kayenmivaam licence for the consideration of US$ 15 million plus a royalty.

11 March 2020: The Group appointed Mr Michael Monaghan as Chief Operating Officer, who would be responsible for overseeing day-to-day operations at all of Company’s Gold production and development assets.

Top Shareholders Statistics

Operating Results for Q2 FY2020 ending 30 June 2020 (reported on 9 July 2020)

Highland Gold Mining produced gold and gold equivalent from four operating mines of 61,357 oz in Q2 FY2020 (Q2 FY2019: 70,293 oz). The total production of gold and gold equivalent stood at 125,347 oz in H1 FY2020 (H1 FY2019: 142,254 oz). The Group expects total production guidance to be in between 290,000 oz and 300,000 oz of gold and gold equivalent in FY2020. The Valunisty and MNV (Mnogovershinnoye) increased stripping by 35% and 101%, respectively, in the first half of the financial year 2020 to access open pit reserves with higher-grade in the H2 of FY2020. The Group is looking to expand operations at Belaya Gora, and Novo (Novoshirokinskoye) and both projects are expected to complete in the current year. The Company continues the construction activities at Kekura as scheduled and started multiple second phase facilities including camp expansion and main processing plant. HGM began construction on Baley ZIF-1 Tailings heap leach project and expected to deliver first gold production in the FY2022 with 15,000 oz of average annual output over 11 years. The Group’s operations, supply chain and sales were not materially impacted by the outbreak of covid-19. The average realised gold price in Q2 FY2020 stood at US$ 1,723 per ounce, and the average realised gold price in H1 FY2020 stood at US$ 1,655 per ounce.

Operational Highlights of FY19 – Increased Production while Maintaining a Low-Cost Position

In FY19, the Company sold 292,287 oz of Gold and Gold equivalent, which was 263,795 in 2018. The total cash cost increased from US$506 per oz in FY18 to US$556 per oz in FY19. During the FY19, the Company also upgraded assets at Novo and Belaya Gora processing plant, with additional exploration at MNV (Mnogovershinnoye). Moreover, the Company sustained the low-cost position against Russian and International peers, which is shown in the picture below:


(Source: Annual Report, Company Website)
 
Financial Highlights – Improved Financial performance in FY2019 (31^st December 2019)

 
 (Source: Annual Report, Company Website)
 
For the financial year ending 31^st December 2019, total production of gold and gold equivalent increased by 12% to 300,704 oz (FY2018: 269,500 oz). Driven by higher production for the period, the revenue increased to $395,386 thousand in FY2019 (FY2018: $311,153 thousand). The EBITDA surged by 34% to $205,079 thousand in FY2019 (FY2018: $153,060 thousand), with an increase in EBITDA margin to 52% (FY2018: 49%). The operating profit stood at $161,483 thousand in the financial year 2019 (FY2018: $109,186 thousand), reflecting increased revenue and EBITDA. The net profit stood at $177,794 thousand in FY2019 (FY2018: $56,084 thousand). The earnings per share stood at $0.487 in FY2019 (FY2018: $0.154). The cash flow from operations (net) increased to $138,448 thousand in FY2019 (FY2018: $136,247 thousand). The capital expenditure increased to $89,275 thousand in FY2019 (FY2018: $62,347 thousand), reflecting an increased focus on expansion activities.

Financial Ratios – Strong Profitability Margins versus the Industry Median
 
 

Reported profitability metrics for the financial year 2019 were higher against the industry median, reflecting higher revenue generated and better control over expenses as compared to the industry. Highland Gold Mining Ltd has delivered a substantial return for the shareholders’ as return on equity of 19.9% was higher as compared to the industry median of 6.1% and surged significantly against last year data. On the liquidity front, Highland Gold Mining Ltd’s current ratio was higher than the industry median of 1.83, reflecting sufficient liquidity to meet short-term obligations, which shows a robust liquidity profile to tackle the uncertainty due to covid-19 outbreak. On leverage front, the debt-equity ratio was 0.31x, which was lower as compared to the industry median of 0.40x, reflecting that the company is less leveraged as compared to the industry.  

Share Price Performance


Daily Chart as on 20^th July 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On July 20, 2020, at the time of writing (before the market close, at 10:57 AM GMT+1), Highland Gold Mining Ltd shares were trading at GBX 231.60, up by 3.86 per cent against the previous day closing price. Stock 52 week High and Low were GBX 282.20 and GBX 150.00, respectively.

Bullish Technical Indicator

From the technical standpoint, shares were trading above the short-term support level of 10-day, 20-day and 30-day simple moving average prices, which reflects an uptrend in the stock and carrying the potential to move up further.

Valuation Methodology - Price/Earnings (NTM)

 

To compare Highland Gold Mining Ltd with peers, Price/Earnings multiple has been used. The peers are Shanta Gold Ltd (Price/NTM Earnings was 18.23), Polymetal International Plc (Price/NTM Earnings was 10.57), Caledonia Mining Corporation Plc (Price/NTM Earnings was 7.23), Serabi Gold Plc (Price/NTM Earnings was 6.29) and Hummingbird Resources Plc (Price/NTM Earnings was 5.08). The Average of Price/Earnings (NTM) of the Company’s peers was 9.48x (approx.).

Highland Gold Mining Ltd Vs FTSE-AIM 100 Index (5 Years)


(Source: Refinitiv, Thomson Reuters)

In the last five years, Highland Gold Mining Ltd share price has delivered 427.38 per cent returns as compared to 29.33 per cent returns of FTSE-AIM 100 index, which shows that the stock has outperformed the index during the last five years.

Business Outlook Scenario

Despite the decline in the production for the first half of the financial year 2020, the Group did not witness any impact on sales, supply chain and operations due to the covid-19 pandemic. The recent increase in the gold prices in the global markets can improve financial performance and bring operational stability. The average realised gold price in Q2 FY2020 stood at US$ 1,723 per ounce, and average realised gold price in H1 FY2020 stood at US$ 1,655 per ounce, which is higher than the average realised gold price of US$ 1,344 per ounce in FY2019.

The Group appointed Michael Monaghan as COO (Chief Operating Officer), which will provide strength to the management team and helps in the operational performance. As per guidance for FY20, the Company is projecting a total production of gold and gold equivalents to be in the range of 290,000 oz to 300,000 oz. The Group has been carrying the construction and expansion activities across projects as scheduled and are expected to complete on time which can boost the production in coming days.

Over the course of 3 years (FY16 - FY19), the company's net income surged from $47.2 million in FY16 to $177.2 million in FY19. Compounded annual growth rate (CAGR) stood at 55.42 per cent.

Based on the decent prospects and support from the valuation as done using the above method, we have given a “Buy” recommendation at the current price of GBX 231.60 (as on 20 July 2020, before the market close at 10:57 AM GMT+1), with lower-double digit upside potential based on 9.48x Price/NTM Earnings (approx.) on FY20E earnings per share (approx.).
 
 
*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.
*Dividend Yield may vary as per the stock price movement.

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