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Gold: lustre all around

Home / Perspectives / Gold: lustre all around

Andrey Kuznetsov, CFA, Portfolio Manager
26 August 2015

Facing a resurgent dollar and the prospect of increasing US interest rates, gold producers have been under a lot of pressure in the past few years. However we believe that gold companies play a vital role in optimising the commodities exposure within a credit portfolio. 

Demand: a different beast

The two largest markets for the gold are China and India, which have 28% and 24% market shares respectively. Given the ongoing industrial slowdown in China, we view this favourably versus many other commodity markets in which the world’s second-largest economy is far more dominant – 80% in seaborne iron ore, 60% in coal, 50% in aluminium and 45% in copper, to name a few. The major end markets for gold are jewellery and investments, enabling the precious metal to provide investors with diversification from many other commodities, which depend on industrial and construction demand.

Figure 1. Global gold demand split by country in 2014

Source: World Gold Council, Hermes Credit

Figure 2. Global gold demand split by end market, 1995-2014

Source: World Gold Council, Hermes Credit

Supply: peak production in 2015

The three-year running average for gold discoveries peaked in 1995, according to miner Goldcorp, and the average 20-year development window means that production is expected to peak in 2015. To quote CEO Charles Jeannes in the company’s most recent quarterly call: “On the supply side, we see lower mine supplies of gold next year and continuing indefinitely.” Our analysis of the all-in-sustaining-cost for major listed gold producers show that the average cost of production of $914 per ounce. However, this metric excludes the interest and cash taxes, which each add another $55 per ounce. Average total cost of $1024 per ounce is not far from the recent lows of $1090 per ounce. As a result, most miners are expected to maintain or reduce production this year and are cutting capital expenditure budgets.

Figure 3. Gold miners: 2015 AISC guidance 

Source: Hermes Credit, company reports.

Still a safe haven

Based on our reading of the minutes from the Federal Open Market Committee meeting in July, the likelihood of a rate hike in September and the pace of policy tightening is still not clear given that almost all members need to see more signs of economic growth and strength in the labour market to feel reasonably confident that inflation is moving towards the central bank’s long-term target. Gold has been a safe haven amid volatility, and China’s decision to make the fixing of the renminbi more representative of market-driven pricing has resulted in a sudden devaluation that surprised the market. The popularity of gold since this move indicates that investors still seek the precious metal in periods of uncertainty as a stable store of value.

Nuggets of performance

The global metals and mining sector has corrected significantly in the year to date period, and investors need to be selective when allocating to the sector. In this environment, we prefer commodities with better supply-demand outlooks and different end markets. We acknowledge that gold has  exhibited correlations with gold exchange-traded fund flows, real US interest rates and the dollar, and has been impacted by weaker year-over-year demand in H1 from both China and India. However, within the global metals and mining sector, we favour gold producers given their different end markets and the safe-haven status of the commodity. We prefer issuers that are positioned lower on the cost curve, are exposed to less geopolitical risk and have demonstrated a strong track record amid lower gold prices – because volatility is likely to continue, particularly when US monetary policy tightens. Credit investors with flexible mandates who do no want to increase their overall exposure to metals and mining could consider CDS pair trades, investing long in stronger issuers and short in names that are more exposed to China’s industrial slowdown.


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Andrey Kuznetsov, CFA Portfolio Manager Andrey joined Hermes in January 2013 and is currently portfolio manager across Hermes Credit's portfolios, having previously been senior analyst covering metals & mining, chemicals and building products. Andrey has extensive experience covering various industries including TMT, paper & packaging, autos, capital goods, and healthcare. Prior to joining Hermes he was at BCM & Partners LLP, where he focused on credit analysis of high yield corporates and assisted the CIO in the management of the multi-strategy credit fund. Andrey holds an undergraduate degree in Economics from State University – Higher School of Economics in Moscow, where he majored in Financial Engineering and Mandarin Chinese, and a graduate degree from London Business School. Andrey is a native Russian speaker and CFA® charterholder.
Read all articles by Andrey Kuznetsov, CFA

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