EUR 850.00 For Business Accounts Only

Morningstar | Buenaventura Records Solid 2Q, but Shares Slightly Overvalued. See Updated Analyst Note from 27 Jul 2018

Buenaventura Mining saw solid production growth during the second quarter, with year-over-year production gains for all metals except lead. Combined with a higher gold price, quarterly revenue grew 26% to $318 million and adjusted EBITDA including associates grew 70% to $191 million. Impressively, EBITDA growth came from improvements at the company’s direct operations as well as its associated investments. In particular, long-troubled Yanacocha saw its cash costs fall 26% due to improvements at the gold mill.

Our full-year forecast is largely unchanged. As a result, we’re maintaining our fair value estimate of $12 per ADR for no-moat Buenaventura. Although the company has done a good job improving the profitability of its operations, we see the shares as slightly overvalued and would recommend waiting for a better entry point.

In June, the U.S. Federal Reserve raised the federal-funds rate by 25 basis points to 1.75%-2%. This was the second rate hike of the year. Most officials at the central bank expect two additional rate hikes in 2018. The market appears to be largely in line with this view, as current interest-rate options prices imply a more than 66% chance that there will be at least two hikes for the full year.

All else equal, the prospect of higher inflation adds to gold's investment appeal, which is one reason exchange-traded fund gold holdings rose through most of 2018 and spot prices remained above $1,300. However, as we had anticipated, higher inflation has emboldened the Fed to pursue rate hikes at a quicker pace, which lifts the real interest rate and, in doing so, increases the opportunity cost of holding gold.

Historically, we've observed a strong inverse relationship between the real interest rate and the price of gold: When the former rises, the latter tends to fall. We thought it was only a matter of time before gold investment adjusts to the higher opportunity cost, not only leading to slowing investment demand, but also outflow of gold from ETFs back into the gold market. Our prediction has begun to take hold as ETFs saw outflows in all regions in June.

On the back of weak investment demand, gold prices have fallen to slightly above $1,200 per ounce. Nevertheless, we still believe gold has a promising future, and we forecast a nominal gold price of $1,300 per ounce by 2020. We expect that, in the long term, Chinese and Indian jewelry demand will fill the gap left by waning investor demand.

For more on why rate hikes present a significant risk to near-term gold prices, please see our August 2017 report "Gold Is Standing on One Leg."