The price of gold in Aussie dollars has NEVER been higher… 3 gold stocks to consider

On Friday, the price of gold that Australian producers receive, reached an all-time record high. Not even when Adam was a boy, did gold trade at this level.

And yet as we can see from this chart, gold stocks have failed to keep pace with the current rally.

Source: Katana and FactSet

There are always reasons for such divergence, and indeed some of them are valid. For example, there is a healthy scepticism that this gold rally will hold. Clearly the horrendous and tragic events in the Middle East have sparked the latest rally. And as with many geo-political events, the impact tends to be transient rather than structural.

At a stock level there are also issues around cost escalation, ever present production issues and declining grades.

But even if gold were to consolidate below the current level, there still appears to be a disconnect between what producers are earning and what they are being valued at. So how are we playing gold? We tend to avoid explorers and categorise gold stocks into 3 buckets:

1. larger scale producers,

2. emerging producers and

3. developers.

Regis Resources Limited

Equities

Our top gold pick was 230% higher when gold was last at this price

View

Tietto Minerals Limited

The emerging end of the market entails a disproportionately higher level of risk and uncertainty, and accordingly, investors should demand a notably higher level of return. Mean reversion does not apply to emerging gold producers. The landscape is littered with producers that have not reverted in any way shape or form to their former self, but rather have continued to decline until the CEO resigns, the plant is put on ‘care and maintenance’ (a wonderful euphemism), the stock is delisted and the company eventually declares bankruptcy. And not necessarily in that order!

We would strongly caution investors to do multiples of their research before investing in such companies. But the rewards are there for diligent and experienced investors. At Katana, we don’t deviate into this realm too often, but one that caught our attention is Tietto Minerals Limited (ASX Code TIE).

Tietto has a market capitalisation of less than $500m, despite having just updated the market with a revised long term production forecast of 170kozpa at an impressive all-in sustaining cost (AISC) of US$982/oz . The peer group that offers similar levels of production, are trading at closer to $800m+ valuations. And few can match Tietto’s low production costs, strong balance sheet and pathway to further production growth. Of course, Tietto is trading at a discount for a reason, being that management failed to deliver to plan during commissioning. So cautious money will wait and watch for signs of improving grade, mining productivity and production. But if Tietto deliver to spec, then the wave of buying will follow.

In the developer segment, we see De Grey Mining Limited (ASX Code DEG) as being the standout. De Grey is looking to develop the world class Hemi Gold project in the Pilbara region of Western Australia. If you could choose any region in the world to develop a gold mine, this would be close to the top of the list.

De Grey Mining

In late September, De Grey released a much-awaited Definitive Feasibility study. This study concluded that the mine would average 530koz per annum at a low cost of <A$1,300 per ounce (versus spot price north of A$3,000 per ounce). On these numbers, the project will repay its capital in 1.5 to 1.8 years on the back of an internal rate of return of 36% post-tax (45% pre-tax)

And almost as important, the study utilised only reserves (99%) which stands at 6moz. Firstly, this provides a high degree of confidence that production will be met. But secondly, it provides substantial upside as the total global mineral resource estimate (MRE) stands at nearly double the reserve (11.7moz) and is open in multiple directions. With the recent in-fill drilling now complete, we would expect to see exploration drilling yield further growth in the MRE in the coming months.

Longer Term Outlook for Gold

As mentioned, the horrendous situation in the Middle East has triggered the short term uplift in the gold price. But this will pass (hopefully sooner rather than later) which will cause this premium to evaporate and the gold price to retrace. The question then, is what is the longer term outlook?

I’m not sure if there is anything harder to call than the gold price, and there is no shortage of conflicting opinions. But when we cut through the noise, what we do note is that US budget deficits are increasing and the interest costs are accelerating. As this continues, the most likely outcome is that the US$ will come under pressure at some point. And a declining US$ has been one of the top drivers of the gold price in past cycles.