Robert Stephens, CFA, discusses the prospects for FTSE 100 gold miners Fresnillo and Polymetal as the world’s economic outlook remains precarious.
While many FTSE 100 index shares have declined in the past year, gold miners such as Fresnillo (LON:FRES) and Polymetal (LON:POLY) have soared.
They have benefited from a rising gold price that has been catalysed by a weak global economic outlook, increased risk aversion among investors, and an accommodative monetary policy pursued by the Federal Reserve. This has resulted in a 90% rise for Fresnillo’s shares and a 50% gain for Polymetal stock.
Even though vaccine rollouts are thankfully gathering pace across the world, Covid-19 is likely to remain a drag on global growth for a large part of 2021. Therefore, in my opinion, valuations present within the gold mining sector suggest they offer market-beating potential.
Further economic challenges
The IMF forecasts that the global economy will grow by 5.2% in 2021, followed by further growth of 4.2% in 2022. While those figures are encouraging after the world economy’s 4.4% decline in 2020, further challenges are likely in the short run.
Notably, containment measures to limit the spread of Covid-19 are set to cause disruption for a large number of industries. Even when transmission rates eventually fall, the economic damage caused by the pandemic is likely to prompt continued monetary policy action by the Federal Reserve.
For instance, the US unemployment rate is still higher than at any point between 2014 and 2020. Likewise, US consumer confidence is recovering, but excluding last year’s exceptionally low readings has not been worse than its current level since 2014. These, and other factors, may provide conditions that support the gold price. Its defensive credentials and lack of opportunity cost from low interest rates may mean its price level remains buoyant.
This outlook is likely to be a cornerstone of the improving financial outlooks for Polymetal and Fresnillo. The former’s bottom line is forecast to be 20% higher this year versus its 2019 level, while the latter’s earnings are expected to more than double in 2021 compared to their 2019 level due to high gold and silver prices. Such large growth opportunities in an era of subdued economic performance may mean that their prospective price-earnings ratios of 13 (Polymetal) and 23 (Fresnillo) are justifiable.
Overcoming potential threats to growth
Gold miners are not immune from the disruption caused by Covid-19. Fresnillo and Polymetal were both forced to close assets in 2020 due to the pandemic. Similar occurrences in 2021 could hurt their production levels. In turn, this would be likely to impact their financial prospects, as well as market sentiment towards their share prices.
Likewise, their dependence on the prices of precious metals dictates that their earnings will, by definition, be volatile. Ultimately, the world economy is likely to return to growth and interest rates could rise as containment measures abate and confidence returns. This may limit the capacity of precious metals prices to make new highs over the long run.
However, the challenging outlook for major economies in Europe and the US could mean rising profitability for gold miners. Fresnillo and Polymetal have vastly beaten the FTSE 100 index in the past year. Further outperformance could be ahead, as the world continues to feel, and respond to, the economic effects of Covid-19.