Gold will remain a financial refuge in these uncertain times and the year-old bull run in gold equities has not yet reached its peak, according to an October 15th report by HSBC.
The document, compiled by analysts Ivars Bergmanis, Victor Flores, Tony Lesiak, Peter Bures and Nawojka Wachowiak, goes on to state that current conditions will make it difficult for the U.S. to finance its current account deficit, thus putting pressure on that country’s dollar.
HSBC forecasts that the trade-weighted U.S. dollar will fall 10% from current levels, which, all things being equal, would translate into a gold price of US$325 per oz.
Of critical importance is the decline in short-term U.S. interest rates to below 2%. Coupled with inflation rates declining to about 2%, real short-term interest rates have entered into negative territory, and HSBC expects these real rates to remain at or below zero for the next 11 months.
“The last time real rates fell below zero coincided with a period of strong, absolute performance from gold,” write the authors. “For these reasons, we have raised our 2002 gold-price forecast to US$310 per oz. [from US$285 per oz.]”
Although there has been some recent profit-taking as a result of gold’s failure to rally toward US$300 per oz., HSBC believes that the metal has entered a new, higher trading range.
One might expect higher gold prices to encourage renewed forward sales by gold producers, though the authors note that the gold contango has in fact been flattened by the decline in interest rates. For example, a 1-year forward sale will net a producer a mere US$3 per oz., and a 5-year forward will yield only US$25 per oz.
HSBC’s higher forecast for gold prices naturally points to a much-improved projected return on invested capital (ROIC) in the gold sector for 2002. Globally next year, HSBC estimates a 7.2% ROIC in the gold sector, whereas North American producers can expect an ROIC of 6.3% in 2002 [up from 5.3%].
“The biggest question now facing investors in gold equities is whether the current rally has run its course and whether the time has come to begin taking profits,” the analysts state. “We believe it is too early to exit the sector. The indicators for the commodity remain positive, and gold continues to provide a favourable outlook when compared to the other mining sub-sectors.”
Overall, HSBC continues to recommend an overweighting in gold stocks relative to the market.
Among the senior producers cited in the report, HSBC recommends adding to positions in:
HSBC recommends reducing three seniors, namely
Among the mid-tier producers, HSBC recommends buying
Under HSBC’s new guidelines for equity recommendations, the company has eliminated its “hold” rating and balances recommendations on the basis of market capitalization (that is, for every “buy” or “add,” there is a “reduce” or “sell.”)
Turning to platinum group metals (PGMs), the authors comment that the “outlook continues to deteriorate.”
While conceding that the bearish sentiment towards platinum has been “overdone,” they also believe that the palladium market “will remain terribly weak.”
In particular, the expected weakness in global vehicle sales during 2002 will have a measurable effect on PGM prices. Accordingly, HSBC is reducing its 2002 platinum forecast to US$450 from US$525 per oz. and its palladium forecast to US$325 from US$400 per oz.
After peaking at a record US$1,080 per oz. in February, palladium has seen its fortunes reversed, owing to manufacturers’ stockpiling, palladium substitution in industrial applications, a rapid slowdown in industrial production (electronics-sector demand in particular) and gloomy prospects for the auto industry.
“The North American PGM producers will find it even more difficult to deliver decent returns as a result of our lowered commodity expectations,” write the authors, who now estimate that the 2002 ROIC for the two PGM producers will decline to 10.8% from 14.4%.
HSBC continues to question the popular view that North American PGM producers will be valued as gold equities and instead cites growing evidence that these companies will be priced on the basis of earnings, much like their South African counterparts.
Using earnings growth as the primary yardstick, HSBC advises adding to positions in
Beyond 2002, HSBC maintains long-term price assumptions of US$300 per oz. for gold, US$475 per oz. for platinum, US$250 per oz. for palladium and US$5 per oz. for silver.
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