My recent articles on gold have focused on the geopolitical and economic uncertainty brought on by Trump Administration policies and $100 billion monthly federal deficits that are propelled higher still by global warming related natural disaster "off-budget" relief spending (see Gold: The Possibility Of A Trump Induced Bull-Run and Global Warming Will Push Deficits And Gold Higher).
We can now add two more positive catalysts for gold: The prospect for significantly lower interest rates and a very bullish technical pattern which indicates a massive breakout to the upside. This current "Goldilocks" environment for higher gold prices represents an excellent opportunity for investors to profit in shares Newmont Goldcorp (NEM), which could easily gain 25% over the coming year.
Federal Reserve Rate Cuts
Sputtering economic growth was on display in this week's job report which reported a dramatic slowdown: Payrolls were up by just 75,000 - much worse than expected. In addition, March’s job count was revised lower from 189,000 to 153,000 and the April number was lowered to 224,000 from 263,000, for a total reduction of 75,000.
The response was immediate and interest rates tumbled. The two-year yield - which closely reflects expectations for Fed policy - fell to 1.77% from an intraday high of 1.89%.
CNBC reported that BMO rate strategist Jon Hill said:
You would think the market is gravitating toward one cut in July, one cut in September and another in December. We have 2.9, 25 basis-point rate cuts priced in for 2019.
That equates to a 0.75 percentage point reduction in the fed funds target rate range, which is now between 2.25 and 2.50%. As a result, and perhaps more important for gold investors, the US Dollar Index also slumped:
Net-net, gold has risen $60/oz over the last seven trading days to $1,340/oz. Bottom line is US interest rates are already low and heading significantly lower. This bearish for the US dollar and bullish for gold. All this makes sense considering interest rates in many parts of the world are actually negative. That is, US interest rates were bound to come down.
Gold On the Cusp Of A Technical Breakout
And while the fundamentals for gold are bullish, the technical charts are perhaps even more so. Well respected technical analyst Carter Worth explained the bullish chart pattern for gold on CNBC Friday. Worth pointed out that gold has made multiple runs over the past five years in attempts to break out above $1,350/oz. Each time it failed. However, Worth says the pattern now shows a bullish wedge pattern with higher lows with the tension very likely to be resolved to the upside:
In addition, Worth said that gold's performance relative to an equal weight commodity index (which includes crude, copper, milk, steel, etc. etc.) just broke out to a new relative high this week:
As a result, Worth expects a massive breakout in gold to the upside.
Newmont Goldcorp: A Stock To Own
Newmont recently closed its combination with Goldcorp and in Q1 delivered $345 million in free-cash-flow ("FCF") while producing 1.23 million ounces of gold with an "all-in" sustaining price of $907/oz:
Source: Q1 Presentation
Newmont is so encouraged by the combined companies' performance and prospects that it declared a special $0.88/share dividend that was paid out on May 1.
Newmont has a nicely diversified global portfolio across four continents with an consolidated all-in sustaining average cost of $935/oz:
Source: Q1 EPS Report
Note the outlook above does not include Newmont's recent Nevada joint venture with Barrick Gold (GOLD). The Nevada JV (61.5% Barrick, 38.5% Newmont) covers all processing and infrastructure facilities for the companies' Cortez, Goldrush, Goldstrike, Turquoise Ridge, Carlin, Long Canyon, Phoenix, and Twin Creeks mines in Nevada. The JV puts the two former competitors working toward significant cost and capex synergies. Given the close proximity of all the mines involve and the sharing of processing and infrastructure facilities, annual run-rate savings are estimated at $500 million.
Source: June Presentation
The bottom line here is that Newmont delivered excellent FCF in Q1 with an average selling price of $1,300/oz. If gold moves meaningfully higher, NEM's FCF generation will soar. Note the $349 million of FCF delivered in Q1 alone equates to an estimated $0.65/share based on 534 million outstanding shares. That compares very favorably to a quarterly dividend that's only $0.18/share. That fact, combined with the company's $3.5 billion cash, bodes well for increasing shareholder returns going forward. In addition, the company expects to ring out further cost efficiencies as a result of the merger - which just closed in April.
Additional shareholder value will likely be unleashed with asset sales. Given the company's merger with Goldcorp and inking the Barrick JV in Nevada, the company can maintain a healthy growth profile and still shed under-performing or non-core assets. Divestitures look likely considering the company's annual production target of 6-7 million ounces as compared to its current production potential of an estimated 7-8 million ounces. Would the company announce another special dividend on the heels of an asset sale? Time will tell.
One aspect of Newmont I really like is that the executive compensation plan is directly aligned with the interests of the ordinary shareholder:
Source: June Presentation
According to slide 17 of the above referenced June presentation, a full 60% of the company's incentive plan is based on operational excellence metrics like earnings and EBITDA per share, ROCE, and production efficiency (i.e. costs). This is an indication that - along with the earlier referenced special dividend declaration - Newmont management has become quite shareholder friendly. In my opinion, shareholder-friendly management is a prerequisite for capital gains for any commodity producer - be it gold, or crude, or natural gas. Newmont's management gets a B+ for aligning itself with the interest of the ordinary shareholder.
Newmont has a relatively strong balance sheet: The current net debt to adjusted EBITDA leverage ratio is a modest 0.3x and the company has an investment-grade credit profile.
Risks include higher energy prices making extraction more expensive. However, oil prices have been falling recently and the upside appears limited given the abundance of global supplies.
Another factor to keep an eye on is the overall cost of extraction as there's some concern that while the Goldcorp acquisition bought production, the mines weren't particularly attractive. That said, most analysts believe Goldcorp was acquired at a favorable price, leaving Newmont a cushion to create value.
But the biggest risk for Newmont would simply be for the price of gold to drop. Pure and simple: Investing in Newmont is a bet that gold is going to break out to the upside.
Many investors have gotten burned by investing in single issue precious metals producers. For those wanting upside to gold exposure while avoiding any company specific risks, I'd recommend a gold ETF like the Spider Gold Trust (GLD) or a fund like the Oppenheimer Gold & Precious Metals Fund (OPGSX), which I covered in a recent Seeking Alpha piece.
Summary and Conclusion
The outlook for gold is extremely bullish because the fundamentals are supportive and, in addition, the precious metal now appears to be on the cusp of a major technical breakout. Leading gold miner Newmont Goldcorp also is likely to move significantly higher. Based on NEM's investment grade balance sheet and my expectations for ~$1.8 billion in FCF generation for full-year 2019 ($3.30+/share), shares could easily trade up to $45 over the coming year - even higher if gold were to move above $1,500/oz - which is certainly possible. At that price, investment interest would likely return to the gold miners in a big way and stocks like NEM would then be priced with a premium growth multiple which is not currently in the stock.
NEM closed Friday at $35.67/share, so if my $45 price target works out it would equate to an annual return of 25%-plus.
Source: Yahoo Finance
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NEM over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.
I am LONG gold bullion.