Perhaps the most surprising price movement since the US election has been that of gold. Following a spike to $1,321 per ounce on election night, the precious metal has fallen back to around $1,220 per ounce.
That’s surprising because Donald Trump’s election win brings a high degree of uncertainty. He plans to implement major economic, social and political change which could cause investors to become increasingly uncertain over the medium term. Further, Trump’s policies are likely to push inflation higher in the coming months and years. His low tax/high spend model may boost US GDP, but a rapidly increasing price level may be a consequence.
Due to the potential for higher inflation and greater uncertainty in 2017, I believe that the gold price will rise significantly. One stock which could directly benefit from this upward move is Randgold Resources (LON:RRS).
Higher uncertainty
Since the US election, investors have been remarkably calm regarding the prospect of a Donald Trump Presidency. The S&P 500 is close to its all-time high, while the FTSE 100 is 4.2% below its record high. However, that could all change once Trump steps into the White House. He is seeking to introduce a wide range of changes which could have a significant impact on the US economic outlook. Since investors are usually averse to change, Trump’s policy programme could cause an increasingly risk-off attitude among investors in 2017.
Further, Trump’s campaign pledges included radical policies such as increasing protectionism to aid US jobs, the deportation of undocumented immigrants and a tougher stance on China. The full effect of such changes over the long term will be difficult to quantify and could lead to investors seeking a wider margin of safety than at this moment in time. Market volatility and heightened uncertainty are likely to be the result.
In such circumstances, gold is likely to be a beneficiary. It has long had a status as a popular risk-off asset. Therefore, I believe that despite its $100 per ounce fall since election night, it could rise once Trump starts to deliver radical policy change in the US.
Higher inflation
Gold should also benefit more-specifically from Trump’s economic policies. He looks set to run a relatively wide budget deficit since he has campaigned on a low taxation environment for businesses and individuals alongside higher spending on infrastructure. In fact, in his victory speech Trump promised to spend $1 trillion over the next ten years on infrastructure. While it may take a number of months for such policies to pass through Congress, the Republican Party’s control over both Houses of Congress means that a wider deficit is much more likely than it was under the Obama administration.
The result of Trump’s economic policies looks set to be a higher rate of inflation. Although this could mean that the Federal Reserve raises interest rates more rapidly than they had previously planned, gold could be a beneficiary. While higher interest rates may make gold less appealing versus interest-paying assets, gold’s historical status as a store of wealth could come into play.
Further, the Federal Reserve may prove to be behind the curve when it comes to interest rate rises and inflation. They may prefer to adopt a loose monetary policy in order to counter uncertainty surrounding the US’s economic future. This would make gold even more appealing on a relative basis.
Randgold’s production
A rising gold price would be good news for gold miner Randgold Resources. According to its most recent quarterly update, it was on-track to meet full-year production guidance. As well as the potential for a higher gold price over the coming months, Randgold is also being boosted by cash costs which were 9% lower than in the previous quarter.
Even if the gold price fails to rise, Randgold is in a strong position to generate higher profitability from increased production and lower costs.
Alongside this, Randgold is increasing production from its asset base. Total production of gold was 7% higher in Q3 2016 than in Q2 2016, with the potential for further production rises in future years as Randgold seeks to define or secure three new projects within the next five years. Therefore, even if the gold price fails to rise, Randgold is in a strong position to generate higher profitability from increased production and lower costs.
Financial strength
Randgold has a sound balance sheet and strong cash flow. Although its aim of having net cash of over $500 million by year-end may now be missed due to gold’s recent fall in price, its cash flow is sufficient to fund exploration and future development. For example, Randgold’s free cash flow increased from $135 million in the first nine months of 2015 to $196 million in the same period of 2016. Some of this is due to the higher gold price in 2016, but Randgold’s strategy remains one of reducing costs and building cash resources for future development.
Randgold’s improved cash flow should also be sufficient to pay a higher dividend, with amounts paid to shareholders forecast to rise by 32% in 2017 so that Randgold yields 1.3%. Profitability is forecast to increase by over 50% on a per share basis in 2016, then by over 30% in 2017. Given the positive outlook for gold in the context of higher inflation in the US and a more uncertain outlook for the world economy, I wouldn’t be surprised if Randgold’s profit guidance was upgraded over the medium term.
Outlook
Although gold has disappointed since the US election, in my view the precious metal has a bright long term future. I believe that Trump’s Presidency will bring uncertainty due to his radical policy manifesto. This could lead to an increasingly risk-off attitude as investors seek safety in a time of intense change. Similarly, Trump’s economic policies could lead to higher inflation, which may raise demand for gold to even higher highs due to its historical reputation as being a successful hedge against sharp price rises.
Randgold Resources should therefore benefit from a more agreeable climate for gold. Its net cash position, improving cash flow, long term strategy and cost reduction programme show that it could perform well even if gold fails to rise. However, in my view the mix of a rising gold price and Randgold’s operational appeal means that it could prove to be one of the very best performing stocks in 2017.
Disclosure: Robert Stephens, CFA, owns shares in Randgold Resources.