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Why I Remain Bullish on Gold Miners

- By Faisal Humayun

In an environment where there are speculations about sustained rate hikes by the Federal Reserve, it is likely investors will be skeptical of increases in gold prices. In general, an increase in interest rates would translate into a stronger dollar and lower gold prices. I remain bullish on gold and gold miners, however, and see current levels as attractive for medium to long-term investments.


First off, even with a rate hike in the recent past, the real interest rates (adjusted for inflation) are still negative. As long as real interest rates are negative, it does signal expansionary policies. I do not see real interest rates being positive even if there is another 25 to 50 basis point increase in 2017.

Second, President Donald Trump is keen on increasing U.S. manufacturing, in which case a stronger dollar will certainly not help the cause. While the Fed seems committed to increasing rates, a stronger dollar can negatively impact the economy and force the agency to reverse its policy stance.

The third point in favor of gold is the fact that expansionary monetary policies continue elsewhere, including Europe, Japan and several emerging economies. Therefore, in the entire economic system, there is ample liquidity to support gold on the upside.

Considering these few factors, I do believe gold is unlikely to see downside from current levels. Rather, there is upside potential. I must add that equities have been trending higher and markets globally look stretched. If there is flow of funds from risky assets to relatively low-risk assets, gold stands to benefit. I see this scenario playing out in the next three to six months.

Gold miners worth buying

Newmont Mining Corp. (NEM) - The gold miner peaked at $45 on Aug. 2, 2016 and has been in a zone of consolidation after a sharp decline. At current levels of $34, the stock is attractive for the medium to long term.

In the coming years, the company will focus on assets that have low all-in sustaining costs and strong financial flexibility. Newmont Mining is well positioned to accelerate investments in core assets. To put things in perspective, Newmont Mining had cash on hand of $2.8 billion as of fiscal 2016 to fund future growth. With net debt to adjusted EBITDA of just 0.8, the investment outlook is robust.

Even at current gold prices, Newmont Mining has been successful in generating free cash flow of $784 million for fiscal 2016. This strengthens the company's balance sheet. Additionally, as gold trends higher in the next 12 to 24 months, I expect free cash flow to be robust.

Barrick Gold Corp. (ABX) - Barrick is also a quality stock in the gold mining industry. In the last few years, the company has done exceedingly well in terms of selling non-core assets to reduce debt and build sufficient financial muscle to invest in core assets.

In 2016, Barrick Gold was able to reduce debt by $2 billion, and the company targets debt reduction of another $1.5 billion for fiscal 2017. In addition, Barrick Gold has no major debt maturity in the near term with $4 billion in available revolving credit facility.

Like Newmont Mining, Barrick also has an attractive AISC that makes it interesting for long-term investments. With 70% of 2017 production likely at an AISC of $650 to $710 an ounce, Barrick Gold is well positioned at current gold prices.

Further, Barrick also reported robust free cash flow of $1.5 billion for fiscal 2016, with FCF breakeven at less than $1,000 an ounce. The company has guided for capital expenditure in the range of $1.3 to $1.5 billion for 2017, implying another year of FCF. This will not only help increase shareholder rewards, but strengthen the company's balance sheet.

Conclusion

Gold has been unsuccessful in breaking out on the upside as the Fed intends to increase interest rates through 2017. Real interest rates, however, remain negative and expansionary monetary policies are continuing in several parts of the word.

This is likely to ensure gold does not decline further from these levels. On the upside, the potential is significant with the triggers I discussed. I therefore see current levels as attractive for investment in physical gold and gold mining stocks.

Disclosure: No positions in the stocks discussed.

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This article first appeared on GuruFocus.