It’s since taken a step back on some light profit taking. But make no mistake, investor demand for the safe-haven remains rock-solid. And this was underlined by recent data from the World Gold Council. According to the body, some $5.5bn worth of inflows, equivalent to 127 tonnes, went into global gold-backed exchange-traded funds (ETFs) in June “as geopolitical uncertainty increased and central banks signalled a shift to a more accommodative policy over the coming months.”

More to come?

This was the largest monthly inflow (in dollar terms) since 2012, and there are numerous reasons to expect gold holdings to keep on bulging.

As signs of a more doveish monetary policy from the Federal Reserve have risen, expectations of interest rate cuts from Brussels and London to Beijing have also gained traction. And the relentless stream of poor economic data from all over the globe means the prospect of several benchmark rate reductions is only likely to rise as 2019 progresses.

Throw the unresolved issue of US-related trade wars into the bargain, Britain slipping closer to the Brexit cliff-edge, and Iran showing little signs of backing down in its high-stakes diplomatic spat with Washington, well there’s plenty of reason to expect bullion prices to keep making progress.

But there’s more than one way to capitalise on the rampant gold price right now. Rather than buy physical bars or coins, or invest in one of those aforementioned ETFs, I believe a much better way to make your money work for you is by buying into London’s listed gold producers.

Dividend darlings

Why? The payment of dividends to investors by such mining stocks are extra rewards which don’t come with playing the gold market. And some of the predicted dividends of  these businesses are pretty darn impressive.

Take Pan African Resources and Polymetal Resources and their forward yields around 4.5%. Or Trans-Siberian Gold and its 5.5% prospective yield.

Of course investors need to be prepared to take some of the risk associated with the mining industry, namely uncertainty over potential payloads and unexpected production disruptions which can hammer output levels and ramp up costs.

However, those diggers I’ve mentioned are all making brilliant progress operationally. Speaking of which, Acacia Mining announced this week gold production surged almost 20% year-on-year in Q2, thanks to blowout production in Tanzania. And what’s the forward yield over at this particular share? A monster 6.2%, if you’re asking.

While all of these yields are pretty delicious, it’s possible to get hold of some bigger dividend payers in the near term at least. However, if you’re looking for a blend of jumbo payouts and the possibility of some stratospheric share price gains in the months ahead, you may well be better off ploughing your investment cash into these mining mammoths instead.

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The theory is attractive but, in reality, I reckon dividend-hunting investors tend to be more conservative than small-cap investors. Indeed, small-cap firms can present us with extreme volatility, and their shares can move much faster than large-cap stocks. I think the two strategies of income investing and small-cap investing probably don’t sit comfortably together for many!

Volatility assured

One wild ride for investors has been provided by gold miner Pan African Resources (LSE: PAF), which has operations in South Africa. Indeed, the share price was as low as 7p in 2015 when I last wrote about the company, but it had shot up to around 22p by the summer of 2016 and is now back down at just above 10p.

However, the volatility is not just because of the company’s small-cap status. All mining companies have been volatile over the period and I think the big swings in operations and share prices tell us more about their cyclical nature than anything else. A great deal of the trading outcome is outside the control of mining companies, which tend to see their fortunes ebb and flow according to the prevailing price of the commodities they deal in which, in turn, is affected by macroeconomic conditions.

I see all mining firms as inherently risky for investors. Right now, Pan African Resources sports some tasty-looking valuation indicators, such as a price-to-earnings ratio of just over six for the trading year to June 2019 and a forward-looking dividend yield upwards of 4%. But I reckon its cyclicality means the firm doesn’t deserve a higher rating. Who knows what the price of gold will do from here? In some ways, I see investing in commodity firms like this as more like gambling than investing.

Trading well – for now

Yet, the half-year report out today is upbeat. Chief executive Cobus Loots explained in the narrative that the firm enjoyed a “robust” operational, financial and safety performance in the period and is “positioned” as a low-cost and long-life gold producer. One negative, as I see it, is that net debt rose more than 160% to £103m, due to the construction of the firm’s Elikhulu tailings retreatment facility. Companies do need to invest to grow, but if there’s a downturn in demand, or if commodity prices plunge, the firm’s borrowings could become problematic.

Looking forward, the directors said there is an “attractive” pipeline of near- to medium-term growth projects. I think, though, it’s a case of you pay your money and you take your punt with small-cap mining shares. The stock could shoot up again from here, but I don’t believe there’s any reliable way to predict the possibility of that happening with analysis – fluctuating commodity prices could change everything. I certainly wouldn’t lead an investment decision on Pan African Resources with the level of the dividend!

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The performance of the mining sector has been akin to a rollercoaster ride in recent years. Commodity prices have been hugely volatile and have come under pressure at times. This has hurt profitability across the sector and caused investor sentiment to decline.

Now though, the ‘green shoots of recovery’ may be present, with investors seemingly becoming more positive about the industry’s prospects. As such, now could be the right time to buy these two mining stocks for the long term.

Growth prospects

Reporting on Wednesday was goldminer Pan African Resources (LSE: PAF). The company’s Barberton Mines are on target to produce around 50,000 ozs of gold in the second half of the 2018 financial year. This would represent an increase of around 23% versus the first half.

The business is also seeking to improve future flexibility and sustain its rising gold production through development to the next high-grade platform. This will commence early in the next financial year and is expected to be in full production in the 2020 year.

Looking ahead, Pan African Resources is forecast to post a rise in its bottom line of 8% in the current year, followed by further growth of 29% next time. Since it trades on a price-to-earnings growth (PEG) ratio of just 0.2 it seems to offer excellent value for money at the present time.

The gold price has been buoyant in 2018. Its rise could be linked to the potential for higher inflation over the medium term. As such, now could be a good time to buy undervalued miners. Certainly, Pan African Resources is a relatively small entity which comes with high risk. But its return potential appears to be attractive.

Confident outlook

Also offering upside potential within the mining sector at the present time is copper miner Antofagasta (LSE: ANTO). The company experienced a challenging period in the recent past, with its profitability coming under severe pressure. However, after making changes to its asset base and seeking to become more efficient, it now appears to be in the midst of a successful turnaround.

In the next two financial years its bottom line is expected to rise by 8%-9% per annum. While this may not be among the highest growth rates in the industry, the company appears to be confident in its future outlook. Evidence of this can be seen in its forecast rate of dividend growth. Shareholder payouts are expected to rise by 9% next year to put the stock on a forward dividend yield of 3.2%. This could make it a realistic income play – especially since dividends are due to be covered 2.2 times by profit next year.

Clearly, the mining sector could experience a difficult period if commodity prices fall. But with the global economy set to perform well, Antofagasta’s PEG ratio of 1.7 appears to be tempting for long-term investors.

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This could be a stunning turnaround investment, as gold market conditions are quite favourable at the moment. But today’s half-year results suggest to me that caution might be wise.

Operational challenges at the group’s Barberton Mines caused gold production to fall by 7% to 85,282 ounces during the six months to 31 December. Guidance for full-year production has now been cut by around 6% to 177,000-181,000 ounces, down from 190,000 ounces previously.

Performance has also been affected by industrial action and by the strength of the South African Rand (ZAR) against the US dollar. This is important because gold is traded in US dollars, but costs are in local currency. A stronger ZAR means that gold sales bring in less local currency, increasing the group’s cash mining costs.

Profits down 74%

The impact of these challenges caused Pan African’s H1 net profit to fall by 74% to just £3.6m. The group’s all-in sustaining cost of mining rose by 17% to $1,268 per ounce. That’s uncomfortably close to the current market price of gold, which is about $1,329 per ounce.

Chief executive Cobus Loots said today that the impact of the ZAR/USD exchange rate means that the group will have to “review higher-cost mining operations”. This could result in further production cuts or one-off costs from restructuring.

It could get better

I wouldn’t write off Pan African just yet. Management expects improvements in production levels and cost savings over the next six months. But the problem for me is that there are just too many unknowns. I’m going to stay away for now.

One stock I’d buy and hold

I don’t normally view small-cap commodity stocks as buy-and-hold investments. But I believe Hurricane Energy (LSE: HUR) could be an exception.

The group now has recognised resources of 2.6bn barrels of oil equivalent. So far, most of these are classified as contingent resources, which means they are known to exist but have not been shown to be commercially viable.

At the moment, Hurricane’s commercial reserves are limited to 37.3m barrels of oil in the Lancaster field. These are being targeted by the Early Production System, which is expected to begin producing in 2019.

However, if the group is able to convert some of these 2.6bn barrels of resources into reserves, then I believe the value of the company could multiply from current levels.

Good timing

It’s worth noting that Hurricane chief executive Dr Bob Trice is playing a long game here. Rather than selling a stake in the Lancaster discovery to raise funds to begin production, he’s gone to the market and raised $520m of fresh debt and equity.

In doing so, he attracted significant investment from oil industry specialist investors, such as Kerogen Capital. The North Sea is attracting a lot of fresh investment at the moment, and if Dr Trice can convert more of Lancaster’s 523m barrels of resources into reserves, Hurricane’s valuation could rise sharply.

In my view, the shares are probably quite cheap at current levels. It could make sense to buy a few today and tuck them away for a few years.

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Operational challenges

The AIM-listed gold miner said that pre-tax profits had slipped to £23m from £33.9m for the 12 months to 30 June, despite a 5.1% rise in group revenue to £169.6m over the same period. Profits were hit by higher production costs which rose from £100.5m to £134m as a result of salary and wage increases, as well as higher electricity costs.

But the group was also hit by significant operational challenges during the year, with production suspended at its Evander mines for 55 days to carry out critical shaft infrastructure refurbishments, and frequent instances of community unrest resulting in lower production at its Barberton mines. Consequently, gold production was down 15.4% on the previous year to 173,285oz, compared to 204,928oz in 2016.

Recovery play

Perhaps unsurprisingly, Pan African’s share price has suffered as a result of the recent issues, shedding 30% of their value in just 12 months. Investors will no doubt have been spooked by the operational difficulties and higher production costs. But management has since taken remedial action and expects a much improved performance in the 2018 financial year, together with a substantial increase in expected gold production.

With the promise of a significant improvement in performance in the coming year, and a price-to-earnings ratio down to just seven, I believe Pan African could be the perfect stock for gold bulls on the lookout for a potential recovery play.

Political and economic turmoil

It’s no secret that mining stocks can be high-risk investments, particularly the smaller Aim-listed resource companies like Pan African. Yes, there are huge profits to be made, but share prices can often suffer from extremely high levels of volatility and investors can suffer huge losses if the timing isn’t quite right.

It’s for this reason that many gold bugs prefer to invest in the larger miners such as Randgold Resources (LSE: RRS). With a market value of around £6.8bn the Africa-focused miner is easily the largest pureplay gold miner on the London Stock Exchange. As with most mining stocks, Randgold’s share price is highly geared to the price of the precious metal it mines. So in effect, the shares are a play on the price of gold.

In times of political and economic uncertainty such as these, investors often turn to the yellow metal as a safe haven. But Randgold’s shares are far from cheap, currently trading on a high earnings multiple of 30. Nevertheless, with Donald Trump in the White House, the threat of political and economic turmoil is never too far away, and gold bulls may well have the last laugh.

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It’s the latest in a long run of good news from Centamin. Like those of its mid-cap peer Pan African Resources (LSE: PAF), shares of Centamin have risen by more than 140% so far this year. Rising production has combined with a stronger gold price and a weaker pound to provide a massive boost to the value of these stocks.

Despite this, shares in both firms still look quite affordable. In this article I’ll explain why I believe both companies could have the potential to deliver further gains for shareholders.

Gold looks well supported

The price of gold has fallen back from a peak of $1,375 per ounce earlier this year to its current level of $1,275/ounce. But according to trade body the World Gold Council, demand for gold was 17.6% higher during the first half of this year than during the same period last year.

Over the same period, gold supply has risen by just 7.5%. This suggests to me that the balance between supply and demand is likely to be tightening in favour of gold miners. In my opinion, gold is more likely than not to rise from current levels.

Will these risks threaten profits?

Choosing between Centamin and Pan African isn’t quite so easy. Both companies face local political and operational risks that could cause problems in the future.

Although they seem largely forgotten, the legal troubles that threatened Centamin’s licence to mine in Egypt in 2012 are still ongoing. An unfavourable outcome seems less likely than it did then, but there’s still a risk of further problems.

Pan African operates in South Africa, so the risk of industrial unrest and rising wage costs can’t be ignored. There’s also the possibility that a future government might change ownership requirements under the existing black economic empowerment regulations.

Exchange rate fluctuations could also affect profit margins at both miners.

I remain positive

Today’s third-quarter update from Centamin showed that the firm’s balance of net cash and cash equivalents rose by $85m to $417m during the period. That’s equivalent to about 19% of Centamin’s market cap, or 30p per share.

All-in sustaining costs for the full year are expected to be towards the lower end of the firm’s guidance of $720-$750 for an ounce. With gold at $1,275/ounce, these low costs should ensure that Centamin remains profitable and cash generative even if the gold rally slows.

Centamin shares trade on 9.5 times 2016 forecast earnings. I remain keen — although it’s worth noting that a profit-sharing agreement with the Egyptian authorities is expected to reduce profits slightly next year.

On balance, I think Pan African Resources may be a slightly more attractive pick. The company has almost no debt and trades on a forecast P/E of just seven. A prospective dividend yield of 5.1% should be backed by free cash flow, and is more than double the 2.3% expected from Centamin this year.

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Positioned for further gains?

Net profit rose by 118% to £25.5m at Pan African Resources during the year to 30 June. The South African firm delivered record gold production, with gold sales up 16.5% to 204,928 ounces.

Earnings per share rose by 120.3% to 1.41p, while the dividend has been increased by 55% to 0.82p per share. This gives Pan African stock a trailing P/E of 13.5 and a dividend yield of 4.3%. This looks very reasonable to me, especially as the average gold price received by the firm last year was just $1,164/oz.

Gold has remained above $1,300/oz. since the end of June, so assuming the market remains stable, the average price received by Pan African should rise significantly this year. What’s less predictable is the effect that exchange rates will have on the firm’s profits.

Pan African operates in South Africa, so the majority of its costs are in Rand. But gold sales are in US dollars and the company’s reporting currency is the pound. The interplay between these exchange rates and the price of gold can have unpredictable side effects. For example, while Pan African’s all-in sustaining costs fell by 20% last year when measured in dollars, they were largely unchanged when calculated in South African Rand.

As things stand, I believe Pan African’s profits are likely to rise this year. Analysts are forecasting earnings of 3.1p per share and a dividend of 0.89p per share for 2016/17. These figures would give the shares a forecast P/E of 6.2 and a yield of 4.6%. This seems cheap enough to offset the risks involved, so I’d be happy to buy.

A safer prospect?

Localised issues can have a big impact on small miners like Pan African. That’s why I tend to focus on larger and more diverse mining groups like BHP Billiton in my own portfolio.

BHP’s profits are rebounding strongly from last year’s lows. Underlying earnings are expected to rise by 150% to $0.56 per share this year, with a further 28% gain pencilled-in for the following year. These figures give BHP shares a forecast P/E of 24 for the current year, falling to 19 next year. The figures may seem high but they don’t reflect BHP’s current ability to generate cash.

BHP generated free cash flow of $3.4bn last year, significantly more than its underlying profit of $1.2bn. This trend is expected to continue this year, when free cash flow is expected to rise to $7bn, versus forecast profits of $2.8bn.

This free cash flow is being used to fund the firm’s growing dividend and reduce debt. Based on the firm’s guidance for the current year, BHP shares trade on just 10 times free cash flow. That’s very cheap for a large, profitable company.

Backed by free cash flow, BHP’s dividend yield is expected to rise to 2.7% this year, and to more than 3% during 2017/18. I believe the shares remain a strong buy.

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In this article I’ll look at two such companies, and ask whether they deserve a place in your portfolio.

A turnaround buy?

Asset management firm City of London Investment Group (LSE: CLIG) issued a mixed set of results this morning. Funds under management rose by 5% to $4bn last year. Pre-tax profits were 3.9% lower at £24.4m.

Earnings per share totalled 23.3p while the firm’s 24p per share dividend was left unchanged for the sixth year, giving a yield of 6.5%. Although this payout isn’t quite covered by the firm’s earnings, City of London’s net cash of £7.2m means that this stable payout is affordable.  

Could City of London be an attractive alternative to big-cap emerging market asset managers such as Aberdeen Asset Management and Ashmore?

Looking ahead, conditions seem to be improving for the firm. The majority of its income is in US dollars, while a large part of its costs are in pounds. The weaker pound following the EU referendum has provided a significant boost to profits.

Emerging market conditions also appear to be improving in some regions. The group’s funds under management have averaged $4.3bn so far this year, up from $4bn at the end of June.

City of London’s house broker expects earnings per share to rise by 33% to 31.5p next year. This puts the stock on an attractive forecast P/E of 11.1, and should provide solid backing for the group’s high dividend yield.

At current levels, I rate City of London as a decent contrarian buy.

It’s not too late for gold

Shares in South African gold miner Pan African Resources (LSE: PAF) have already doubled this year, but I think that this well-funded firm may still have more to offer.

Pan African’s earnings were given a twin boost during the last financial year, which ended on 30 June. The firm’s average realised gold price in South African rand rose by 21.6% over the period. Alongside this, the group’s gold production rose by 16.5% to 204,928 ounces.

Unlike some larger gold miners, Pan African has a healthy balance sheet and generates strong cash flow. The group’s net debt at the start of August was just £13m, which is less than half Pan African’s forecast net profit of £33.5m for last year.

Pan African is expected to pay a total dividend of 0.61p for the year just ended, giving a trailing yield of 3.2%. The payout is expected to rise strongly during this year to 0.89p, giving a tasty 4.8% forecast yield.

The stock currently trades on 10 times 2015/16 forecast earnings. However, analysts expect earnings per share to rise by a whopping 69% to 3.08p this year, giving a forecast P/E of 6.

Although South African mining companies do face certain political risks, Pan African’s modest valuation and rising dividend yield mean that I rate these shares as a buy.

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One reason for this could be that investors are encouraged by Shell’s progress with the integration of BG Group. In its recent Q1 results, Shell said that cost savings so far this year have cancelled out the extra cost of taking on the operation of BG’s business.

These economies of scale also extend to capital expenditure. Shell expects to spend $30bn on capital expenditure this year, including BG capex. In contrast, Shell alone spent $33bn on capex in 2015.

It was always likely that the cost savings from integrating BG’s business would be greater than expected. That’s how these things are meant to work. The timing of the original deal looked poor, as the oil price kept on falling. However, this has probably contributed to Shell’s ability to make bigger savings more quickly than expected.

Overall, I’m bullish about Shell’s decision to acquire BG. I believe this $54bn deal will give Shell the opportunity to cherry pick long-term projects and raise a useful amount of cash from selected divestments.

Should you buy this 7.6% yield?

The elephant in the room is Shell’s 7.6% forecast dividend yield. If the company can maintain its dividend payout while profits recover, then I’d argue the shares are a strong buy.

So will Shell’s dividend be cut? This year’s expected payout of $1.86 per share won’t be covered by forecast earnings of $1.11 per share. However, the latest consensus forecasts suggest that Shell’s adjusted earnings will rise by 83% to $2.03 per share next year. This should mean that the dividend is covered by earnings.

Unless the outlook worsens dramatically, I think a dividend cut is very unlikely.

I rate Shell as a strong buy, but the firm’s £129bn market value may limit how fast the shares can rise.

A smaller commodity play

If you’re looking for a commodity stock with the potential to deliver decent gains in a recovering market, you may want to consider gold miner Pan African Resources (LSE: PAF).

Pan African has already been a strong performer this year, climbing 78% on the back of the 15% rise in the price of gold. This rapid gain may not be repeated immediately, but I do believe this stock could rise further.

Pan African’s latest results show the firm’s all-in sustaining cost of mining is $908/oz. During the six months to December 2015 — before gold’s recovery really got under way — Pan African’s profits doubled from £5.5m to £10.9m.

Analysts expect a full-year profit of £31.4m in 2016. This equates to adjusted earnings of 1.8p per share, and puts Pan African on a forecast P/E of just 7.9. Unlike many gold miners, Pan African has been consistently profitable throughout the gold slump. With the exception of 2012, the firm has maintained dividend payouts for shareholders.

I’m pretty confident that this year’s forecast dividend of 0.72p per share will be paid as forecast. This gives the stock a prospective yield of 5%.

I believe Pan African has the potential to outperform the wider market over the next few years.

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Investing in the miners will be a good idea

At some point, buying into mining firms will end up looking like a good idea. Eventually commodity prices will stop falling and so will the mining companies’ share prices. When commodities bottom out, miners that still survive will be well placed to benefit from any upside potential that may develop from rising commodity prices in the future.

I’m singling out Pan African Resources as the firm most worthy of further research from this collection of three. Let me explain why.

The hurdle of surviving the current rout could yet prove insurmountable for some mining firms — some have high loads of debt that could prove unserviceable if those firms’ profits evaporate completely.

How can we tell when to time a jump into the miners? Perhaps traditional valuation indicators such as price-to-earnings ratios, dividend yields, and price-to-asset values could serve well. I’m sceptical about that. How can such metrics deliver a meaningful solution to the valuation problem when nobody knows what commodity prices will do next? Will the price of iron ore, copper and other resources flat-line from here, will they rise, or will they halve and halve again? The mining firms’ directors don’t know, nor the City analysts and private investors like us.

How I’d time the jump into the miners

We could try to work out what supply and demand for commodities is likely to do for commodity prices going forward. However, that approach seems fraught with difficulty and potential to arrive at inaccurate results.

Company-specific economic factors and investor sentiment drives share prices, so one way of timing an entry into the resources sector is to look at the charts for commodities and mining firms. Charts show us the picture on the ground. They tell us where prices have been. They indicate, for example, if prices are trending down, up, or whether they are flat. The full weight of opinion from the wider investment community drives share prices, so we should observe, I’d argue — even then, charts won’t tell us what will happen next.

That said, when it comes to out-and-out cyclical firms such as the mining companies, buying into a share price that is still falling seems like a poor idea, no matter how tasty those traditional valuation metrics become. I’d argue that we should wait for a price fall to stop, and for the share price to bottom-out and stay there, before even thinking about buying. Right now, we see a bear market in commodities. So, perhaps it’s even better to see an uptrend develop with a few higher lows in place as the shares start to wiggle back up. If we allow for that, there’s at least some chance that the underlying business’s operational convulsions might have settled down a bit, and we can start to gain a clearer picture of how well the firm is coping. Perhaps we can then start to take notice of those valuation metrics again.

To sum up, my rule-of-thumb criteria before investing in the miners now is:

1) Survivability — what is the magnitude of the firm’s debt burden?

2) A change of trend — is there a clear and tested bottom in place for both the underlying commodities that the firm relies upon for its living and in the company’s share price?

This kind of approach doesn’t look very intelligent, I know, but does seem like a pragmatic way of attempting to preserve capital — it’s dead easy to be wrong for a long time with a contrarian mindset. These are cyclical firms, which means they make dangerous buy-and-forget investments.

How these three firms compare

The debt loads and price-chart movements look like this:

Pan African Resources has the smallest load of debt, which ticks the box for survivability. The firm also has a share price that seems to have stopped falling, unlike the other two firms, which currently have no such indication on their charts.

That’s why I’d start my research with Pan African Resources from this assembly of three. First, I’d dig into the underlying charts of the resources the firm produces and then visit the traditional valuation indicators that carry more weight now the chart, and operations, no longer appear to be in freefall.

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