In the last month Newcrest Mining Limited (ASX: NCM) has fallen by 14%. This is a worse performance than the wider resources sector. For example, Woodside Petroleum Limited (ASX: WPL) and Fortescue Metals Group Limited (ASX: FMG) are up 1% and 6% respectively. This fall in Newcrest's share price may cause investors to consider its purchase. However, Newcrest's outlook is uncertain in my view.
Gold Outlook
Gold production dominates Newcrest's business. It accounts for 85% of its total revenue, with the remaining 15% derived from copper production. However, the future for the gold price is uncertain.
On the one hand, there is uncertainty surrounding the outlook for the global economy. The US election and fears regarding the ability of central banks across the globe to stimulate economic growth means that many investors are adopting a 'risk-off' attitude. Gold is viewed as a relatively safe asset and a flight to safety could push its price up from the current level of US$,1310 per ounce.
Further, the continued rise of the middle class in India and China could positively catalyse the price of gold. Around 60% of global demand for gold is for jewellery and technology rather than from investors. China and India are the world's largest consumers of gold and further economic growth in those countries could positively impact on the price of gold.
However, I believe that rises in the price of gold will be moderated by US interest rate rises. The Federal Reserve is forecast to raise interest rates at least once in the next year. Since gold pays no interest, this would make it less appealing compared to interest-producing assets.
Price taker
Due to its focus on gold production, Newcrest is a price taker. This reduces the size of its economic moat and in my view it lacks a competitive advantage versus its peers. Its cost base is not among the lowest in the industry and management is still attempting to turn around the performance of the business following the acquisition of Lihir. Although I feel that the bursting of the mining bubble in Australia will help cut Newcrest's costs, its return on capital employed (ROCE) of 6.2% is relatively low.
Asset base
Newcrest's asset base is high quality and its deposits are large. This brings significant exploration upside as well as expansion options. Further, Newcrest's reserves are large and its mine life is among the longest in the industry. This provides expansion potential in production levels as well as leverage should the price of gold continue to increase after its gain of 23.5% in the last year.
However, challenges remain in turning around its Lihir operations. The optimisation programme which is being followed by management could fail to make a materially positive impact on Newcrest's earnings.
Outlook
Given the uncertain outlook for gold and Newcrest's status as a price taker, I believe that it is a high risk investment. Its shares now offer better value than they did a month ago, but Newcrest's P/E ratio of 31.8 shows that it remains far from being good value. Therefore, taking a look at these three blue-chips is a good idea.
