The resources sector has been a tough place to invest in recent years. Commodity prices have slumped and partially recovered, which has meant high volatility for stocks operating within the industry. Looking ahead, more uncertainty could be on the cards and this could lead to above-average volatility in the current year. However, it could also mean high rewards, as shown by the 30% potential upside in this mining play.
Today's update from gold miner Acacia(LSE: ACA) shows it is making strong progress with its current strategy. Revenue increased by 21% in 2016, due in part to a gold price which was 7% higher. However, it was also because of a 13% increase in gold sales. Alongside this, the company was able to reduce operating costs and this caused EBITDA (earnings before interest, tax, depreciation and amortisation) to more than double versus the 2015 level.
Encouragingly, the company's gold production of over 829,000 ounces exceeded its initial guidance for the year of 750,000-780,000. This boosted the net cash position of the business by around 107%, while dividends for 2016 are more than double those of 2015. A return to free cash flow generation indicates that more dividend growth and investment in future production could lie ahead over the medium term.
Gold miners such as Acacia and Polymetal(LSE: POLY) could enjoy significant share price gains this year. The popularity of gold may increase if uncertainty in the outlook for global GDP growth continues. This may drive more investors towards defensive assets such as gold, which would provide a boost to both Acacia and Polymetal's bottom lines.
Additionally, higher inflation in the US may be ahead, since President Trump has promised a looser fiscal policy. In times of higher inflation, gold could become more in demand due to its historic status as a hedge against a rapidly rising price level.
In addition to the future potential for gold, Acacia is expected to record a rise in its bottom line of 85% in the current year. This puts it on a forward price-to-earnings (P/E) ratio of 14.5. This appears to be a relatively low valuation based on its historical P/E. It has averaged 21.7 in the last five years when the stock has delivered a net profit. As such, there seems to be scope for a 30%-plus rise in Acacia's share price, which would still leave it trading on a P/E ratio of 18.9. This would leave a margin of safety in case there is volatility in the gold price during the course of the year.
However, when it comes to capital growth prospects, sector peer Polymetal may be more enticing. It trades on a P/E ratio of just 10.7, which indicates there is significantly greater upward re-rating potential than is the case for Acacia. Both stocks could benefit from a higher gold price this year, but Polymetal's wider margin of safety and lower valuation mean it could prove to be the superior buy in 2017.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.