Investec: Gold shares should shine in 2015

We expect 2015 to be very similar to last year for commodities, as China’s slowing growth trajectory will likely continue to dominate the overall outlook. However, we still see opportunities, and precious metals are particularly exciting for us.

Good year for gold

The significantly lower oil price is the biggest differentiator from last year, which means the US is unlikely to raise interest rates in the middle of this year. Therefore we will see a continuation of very low global real rates, which is positive for the gold price. Contrary to the consensus view of $1 250 per ounce, gold has performed very well from the start of the year, with the spot price above the consensus view. In a world where Swiss depositors have to pay to keep their money in a bank, gold as a currency starts becoming very attractive.

Even very mild increases in the gold price will result in upgrades to the consensus view. This is completely at odds with the rest of the commodity complex, where, if spot prices hold, the consensus needs to be downgraded.

Shares expected to shine

Given that the gold price is better than consensus, South African gold shares are very attractive. After a very poor performance for many years, these shares have had a good start to the year. The market’s expectation of a weaker gold price is already embedded in the earnings forecasts.

Furthermore, the management of companies have started running their business for a lower gold price environment. The past few years have seen companies reducing operational and non-operational costs, such as capital expenditure, exploration costs, head office and staff expenses. The lower oil price has also helped lower diesel costs.

Therefore, the higher gold price and slimmer cost lines should provide for some upside surprises for gold companies’ results. We do not believe the shares are priced for this and this presents the kind of opportunity we look for in our stock selection process.

Pick of the bunch

Our preferred gold share is AngloGold Ashanti: it has been the worst performer and the market fears it might need to do a rights issue. We’re of the opinion that the management team will do everything in its power to avoid a rights issue, which includes displaying its superior cash flows and possibly even asset sales.

In contrast, we are not optimistic on the prospects for platinum equities. We believe the price will move higher, but only in line with gold. In fact, we foresee a much closer relationship between the platinum and gold prices in the near future, compared to the ratio of nearly 2:1 that it has had in the past.

This skewed ratio in the prices of these two metals was due to the creation of non-price dependent and legislatively-driven demand for catalytic converters. Looking ahead, platinum will exhibit its precious metal safe-haven characteristics – similar to what gold does. However, with the European economy still rather tepid, industrial demand is unlikely to grow sufficiently to see the platinum price outstrip gold.

Platinum shares priced for earnings leap

Contrary to this, platinum shares seem to be pricing in an almighty leap in earnings, which will only come about if the platinum price is significantly higher (approximately $1 500 – $1 600). We expect platinum companies to show good operational results, as their post-strike recovery appears to be very good. However, at current metal prices of around $1 220, these companies are not producing any free cash flow.

As mentioned, while we do expect the metal price to rise, it is not sufficient to justify the current share prices. Some of the higher-cost platinum producers, such as Impala and Lonmin, are under strain.

The sector is also likely to see some corporate activity, as Anglo American Platinum – our preferred pick in this space – makes progress in its disposal of the high-cost Rustenburg and Union mines.

Bulk commodities, oil

With China’s growth trending to a much slower 5.5%, the outlook for bulk commodities – such as iron ore and coal – is not encouraging. Although prices are cutting deep into the cost curves of these commodities, limited supply cuts – and in the case of iron ore, significant new supply growth – will continue to see these markets in a significant surplus.

The oil market has similarly been weighed down by a combination of weakening demand fundamentals and an abundance of supply, as US shale gas has continued its prolific growth and OPEC decided not to cut its production. The current oil price has also pushed a significant part of the oil industry into a loss-making position. However, contrary to what has occurred in the bulks space, we have already seen decisive supply cuts by marginal US shale gas producers.

Conclusion

While commodities in general are unlikely to shoot the lights out this year, there are still very exciting opportunities for careful stock-pickers. We believe it is prudent to be defensively positioned over the next six months as we approach the trough of the commodity cycle and focus our stock selection on quality names with solid balance sheets and sustainable dividends. A stock that stands out in this regard is BHP Billiton, which continues to generate positive cash flow – even at these depressed commodity prices, and offers a dividend yield in excess of 6%. On top of this attractive yield, it is also expected to spin out some non-core assets in the shape of South32.