Is it time to sell Newcrest Mining Limited shares?

Australia’s largest gold miner, Newcrest Mining Limited (ASX: NCM) continues its move higher as gold climbs amidst ongoing market uncertainty. In fact, whilst other commodity producers like BHP Billiton Limited (ASX: BHP) and Woodside Petroleum Limited (ASX: WPL) reveal deepening losses, Newcrest and fellow gold stocks remain one bright light in what has been an otherwise disappointing year for the S&P/ASX 200 Resources Index (ASX: XJR).

Given Newcrest has risen almost 30% this year alone, I believe investors should take profits and sell Newcrest.

Golden gains

Gold is traditionally seen as a safe haven asset which markets turn to during bouts of volatility. Unlike other raw commodities such as iron ore, copper and oil, gold has no large scale fundamental use, meaning its supply and demand metrics are driven by intangible forces like fear and greed (to put it crudely).

Although gold is used in jewellery making, the bulk of demand comes from investor appetite as a hedge against inflation. Investors and the world’s reserve banks often buy gold as a hedge, storing it in vaults so that it can be redeemed for cash at a later date. The premise goes that given governments can’t be trusted to not debase currencies, gold acts as the safe haven to prevent monetary tampering. With markets using gold as their go-to hedge for uncertainty, in times of volatility, gold shines brightest. Recent events demonstrates just that.

The continuing OPEC saga, China’s growth uncertainties and the ongoing fight against deflation in Europe and Japan have meant volatility is nearing all-time highs. With investors becoming more jittery about global events, gold benefits as demand for it increases. The precious metal has risen close to 15% this year, trumping the returns from most other commodities. However, bearing in mind that it has minimal industrial use, these gains might be short lived if normal market activity resumes.

Operational metrics

In its 2016 half-year results, Newcrest reported a 13% drop in revenues, despite a 6% increase to production volumes. Underlying net profit after tax increased to US$63 million and free cash flows were up 19% to US$254 million.

However, Newcrest failed to pay a dividend. To me, this implies that management is still constrained by cash flows and deems it prudent to conserve cash. As such, I believe the underlying business is unsustainable at current gold prices, implying that a continued increase in the gold price is required to ensure the company is sustainable over the long term.

Whilst it is entirely possible that gold could continue rising, the fact that its underlying driver for demand is somewhat artificial leaves me loathed to recommend purchasing gold stocks.

Foolish takeaway

Gold stocks like Newcrest are what I like to term as trading stocks. These stocks rise rapidly in certain cycles and fall just as hard in others, making them excellent for short-term investments (when predicted correctly). They’re not, however, the stuff long-term investments should comprise of.

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Motley Fool contributor Rachit Dudhwala has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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