Geopolitical tensions set to maintain gold’s allure in 2020

Gold is poised to perform strongly in 2020, with geopolitical risk set to remain elevated, according to Wood Mackenzie.

Miners are set to enjoy bumper margins and the trade-off between investing for the long-term and returning money to shareholders will be acutely apparent.

It is crucial that miners capitalise on this moment in the spotlight to secure their long-term position within the industry.

What are the biggest trends to watch in the global gold market in 2020? Rory Townsend, Wood Mackenzie Head of Gold, sees four key themes:

• Geopolitical risks are set to remain elevated
• M&A activity is expected to have a bumper year
• Replenishing reserves will be a key area of focus for miners
• Project approvals should garner increased support - if the price remains compelling

Townsend said: "In Q4 2019, gold prices were buffeted by the combative rhetoric emerging from trade talks. As such, the US-China trade war - and steps taken toward a resolution - will have a pivotal impact on gold in 2020.

“Given the unprecedented scale of the tariffs, it is difficult to draw parallels with the events of today. The volatility of 2019 provides us with a good gauge as to how the gold price could respond to a more significant de-escalation in the trade war. What we can be sure of is that any further trade talks will likely be shrouded in uncertainty, with gold set to fluctuate accordingly.

"At the same time, the US drone strike that killed the top Iranian military commander marked a dramatic escalation in tensions in the Middle East and subsequently pushed the gold price to near seven-year highs. It’s safe to assume the trade war will not be resolved overnight and therefore protectionist policies will keep central bank demand for gold strong. Meanwhile, while one hopes that a peaceful resolution is achieved in the Middle East, any further deterioration in relations will only provide support to safe-haven gold demand.

"The geopolitical landscape means that gold miners are set to enjoy very healthy margins through 2020.”

As majors continue to dispose of non-core assets and mid-tier producers solidify their position within the industry, Wood Mackenzie expects their advisers to prosper.

“The last bull run that peaked in 2011 saw many gold miners pay excessive premiums for acquisition-driven production growth on the proviso that prices would continue to be well supported. The correction in prices that occurred was ultimately accompanied by a wave of hefty write-downs. Miners seem to be taking a more considered approach this time around and any cavalier transaction proposals are likely to be quashed in their infancy by shareholders.

“Nil-premium mergers with peers will, in theory, help remove duplicate overheads and unlock shareholder value. The acquisition of projects such as Massawa, an asset that did not meet Barrick’s investment criteria, and age-beleaguered mines by enthusiastic mid-tier companies should help to progress their commissioning or galvanise their return to former glory days of prosperity.

“However, while the geological potential of these assets is evident and while they may not have had prominent positions in their previous companies, a change in ownership is not necessarily a panacea to an operation’s issues,” added Townsend.

M&A is one way to drive higher reserves but the net benefit this has on the industry will be muted, according to Wood Mackenzie.

Increasing exploration spend and adjusting the price at which reserves are deemed economic are two other options available in a miner’s arsenal.

In 2019, exploration spend turned a corner and Wood Mackenzie expects to see this increase in activity sustained in 2020. Townsend said: “However, with the increasing depth and geological complexity of gold deposits, exploration spend does not necessarily translate into reserve ounces.

“Elevated spot prices pose an interesting conundrum for miners looking to expand their reserve base by categorising more gold ounces as economically extractable. When the price peaked in 2011, many producers eagerly, but disastrously, incorporated higher prices into their reserve estimations. The subsequent fall in price led to large reserve write-downs, with mine lives shortened, mine plans hastily reconfigured and eye-watering impairment charges booked.

“Producers are reluctant to repeat these mistakes and current spot prices are unlikely to solicit a knee-jerk reaction in the end-2019 reserve models. That said, with prices above US$1,550/oz, adjusting reserve prices is a tempting proposition and one that may test some miners’ resolve.

“Regardless of the path pursued, using this time to replenish lost ounces while the appetite for gold is robust will be critical in averting a decline in future gold supply.”

Miners have been committed to their mantra of capital discipline and Wood Mackenzie does not expect this to change markedly. However, when coupled with lofty price projections, this should mean miners soon face the conundrum of how to spend their cash.

“Returning money to shareholders and share buybacks may prove to be the most popular decision. We have already seen Newmont announce a 79% increase in their quarterly dividend and a US$1 billion stock repurchase program. Frugality will be valued by those investors with a nearer-term lens, however this would likely be to the detriment of long-term growth.

“There will be other miners who are likely to leverage the allure of gold prices above US$1,500/oz to justify reinvestment in growth projects.

“Brownfield expansions at assets with proven operational performance are possible candidates to receive board approval. An example would be Polyus’ Blagodatnoye operation where they are considering the construction of a new 6 Mtpa mill, which would raise the processing capacity to 15 Mtpa.

“Smaller scale greenfield projects that can be commissioned quickly and have a short payback period are also likely candidates to benefit from gold’s moment in the spotlight.

“Operations located in lower sovereign risk jurisdictions are becoming increasingly coveted and Canadian gold mining will be a beneficiary of this. There are, however, still promising opportunities elsewhere for those who understand and can navigate above-ground risks,” added Townsend.