Everything you always wanted to know about the future of gold stocks and much more is now answered in this 79 page monster of a report just released by Morgan Stanley, which finally joins the crowd and goes megabullish on gold stocks, by estimating that "currently c.$1500/oz of value is accounted for in reserves in the ground – so, at a $1800-1900/oz gold price, this leaves $400-500/oz for stakeholders, of which shareholders come last (after debt servicing and tax/royalties). While this is a blunt tool, we do believe it provides a good illustration how the sector has historically discounted the spot gold price, but currently does not seem to believe that the current $1800/oz gold price will hold. Thus, we believe an opportunity exists to invest in reserves in the ground rather than bullion (ETF)." So for those who do not wish to chase bullion at record prices (although with currency collapse increasingly imminent, that is probably not a lot), here is MS' conclusion: "Broadly, on stock performance we would make the case for: i) primarily, operating delivery; hence, which stocks look to offer value in their reserves through volume growth and cost reduction. ii) secondly, in the extremes of gold price movement, operating gearing can, but generally does not, supersede operating delivery; theoretically, higher operating gearing generally implies lower quality assets associated with difficult cost/volume control, hence our caution in looking at operating gearing in isolation from operating delivery and track record. iii) thirdly, valuation (but need to adjust for regional risk factors, by-product discount to rating, track-record and risk of delivery). Apparent valuation anomalies can rapidly be erased by big movements in the gold price or failure to deliver to operational expectations. Stocks screening favourably on a balanced gold price outcome (and rated OW by Morgan Stanley analysts) include ABG, ABX, BVN, PMTL. While several of the growth stocks (RRS, KGC, GG) screen less well, delivery on the operating expectations would likely be positive stock drivers." Of course, as much as we like gold and its derivatives, Morgan Stanley's outright push is nothing short of an attempt to get investors to move away from physical into a stock certificate deliverable (and hence, "confiscatable") which is ultimately in the hands of the DTC: something, which, with the world on the edge of complete insolvency, we would hardly advocate.
With gold at record highs, our detailed analysis of the performance drivers of 50 gold stocks (67% of global gold production) indicates operational delivery (reserve growth and cash cost) prevails over valuation. While we are positive on gold and prefer equities on operating gearing and valuation, operational delivery is key. Preferred stocks: ABX, ABG, NCM, PMTLq, 1051.HK.
Prefer gold equities to bullion at spot: Global gold equities underperformed gold by 30% as gold rallied 46% y/y. We (1) estimate the equities discount c.$1500/oz; (2) retain a positive gold price outlook; and (3) now prefer gold equities to bullion at spot, with the added kicker of operating gearing. The proviso is delivery – but, following a decade of rising costs/capex and volume under delivery, the investment reflected in cost stability and volume growth should start to bear fruit. We select our preferred stocks based on converting reserve growth/investment into volume growth of low cost production, not solely on operating gearing.
Special Feature – Gold Equity Performance Driver Analysis (pages 5-10); what 50 stocks are telling us: We screened 50 gold stocks globally for drivers of stock performance over a 5-year period. While significant stock specific drivers exist, broadly two operational drivers in combination stand out: (1) 5-year reserve growth, and its potential as a leading indicator of production growth, (2) cash cost position and outlook for cash flow. Valuation, while important, does not appear to have been a material driver relative to these operational factors. We view operating gearing as a potential future driver – but it favours the equities in general, relative to bullion, rather than specific high cost producers.
Value or growth? Stocks that screen well and rated OW are ABX, ABG, NCM, PMTL, 1051.HK. Generally, stocks screening well on volume growth (and cost) are not OW rated given their valuation, which our study suggests may not be a material near-term headwind if they deliver operationally. The S. African sector screens fairly poorly on relative operating metrics (cost, growth) – the investment case being operating gearing and valuation (ANG and GFI, both OW rated).
Full report attached: