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Morningstar | Lowering Kinross' FVEs as Pause of Tasiast Phase 2 Development Offsets Decent 2Q

During Kinross Gold's second quarter, attributable production fell 13% to 605,049 gold equivalent ounces and cash costs rose 16% to $767 per gold equivalent ounce. However, this was largely in line with expectations, and the company is well on track to reach full year guidance of 2.5 million gold equivalent ounces at cash costs of $730 per ounce.

For the most part, the company's development projects advanced as expected. Tasiast Phase 1 is in the final stages of commissioning, and Round Mountain Phase W is progressing on plan. Fort Knox Gilmore has begun early work after receiving approval in June, Bald Mountain Vantage Complex is progressing on plan, and Russia satellite deposit development continued. In addition, a feasibility study for La Coipa’s potential restart is still expected in the second half of 2019.

However, the same positivity doesn’t extend to Tasiast Phase 2. Although Kinross has continued dialog with the Mauritanian government, which seeks to expand the country’s economics, the lack of a key permit has led the company to put Phase 2 development on pause. Phase 2 would have boosted Tasiast’s throughput from 19,000 tonnes per day to 30,000 tonnes per day, adding significant production growth.

Kinross maintained its 2018 guidance and most development projects continued as expected, so most of our model is unchanged. However, we now model a 50% chance of Tasiast Phase 2 being developed, compared with our previous forecast that it would open. In addition, we’ve trimmed our exit multiple assumption to 6.5 times from 7 to better reflect future free cash flow conversion. As a result, we’re lowering our fair value estimate for no-moat Kinross to $4 per share and CAD 5 per share from $4.50 and CAD 6, respectively.

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 adjusted to the higher opportunity cost, leading not only 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."