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Gold industry stock outlook – Will the shine last?

Gold industry stock outlook – Will the shine last?

Gold prices surged to a three-month high of $1,169 on October 12, after the Federal Reserve published the minutes from its latest meeting. The clearly dovish tone that revealed that policymakers are in no rush to raise borrowing costs, considering the volatility in financial markets and concerns about China's economic slowdown and its potential spillover effects to other economies, led to the surge. China's slowdown appears to have started having a bearing on U.S. exports as well, further weakening the country's economy. 

Moreover, the Fed believes that inflation, one of the major economic indicators in deciding rate hike, will not hit the two percent goal even by the end of 2018. The soft September jobs data has likely further confirmed the market's Fed expectations. This has led the dollar to hover at three-week lows. Dollar weakness usually benefits gold as it boosts the metal's appeal as an alternative asset and makes dollar-priced commodities cheaper for holders of other currencies. 

The spike in gold prices moved up the share prices of certain gold miners, like Barrick Gold Corp.IAMGOLD Corp., Goldcorp Inc., Yamana Gold, Inc. and Newmont Mining Corp.

However, earlier in 2015, the specter of the much anticipated rate hike loomed over gold prices. Easing of political tensions also couldn't help the cause of gold. In July, prices had plunged to the lowest levels in five years.

The precious metal lost its sheen because of a strengthening dollar and China's shocking revelation after six years about its gold holdings, which was much lower than market expectations. According to from the Chinese central bank's data, the country's gold reserves stood at 1,658 tons at the end of June, a 57 percent increase from Apr 2009. 

Let's take a deeper look at the other price drivers - the classic case of supply and demand. 

Global Demand Dragged Down to 6-year Low by Jewelry 

As per the World Gold Council, total gold demand dipped 12 percent in the second quarter to a six- year low of 914.9 tons. A 14 percent drop in jewelry demand to 513.5 tons was the main culprit behind this due to weakness in the key markets of India and China.

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In India, extreme weather and its consequence on rural household income (accounting for more than half of Indian gold demand) and lack of festival and wedding buying led to an unceremonious 23 percent year-over-year fall in jewelry demand. In China, demand for gold jewelry dipped five percent due to slowing GDP growth and rallying stock markets.

While demand in the Middle East faced increase in VAT, lower oil prices , and currency weakness, demand in Turkey dipped as local prices jumped to record highs due to a plummeting lira. Only the two percent year-over-year increase in U.S jewelry demand is worth mentioning as consumers made use of the lower prices. 

In the technology sector, gold demand was down one percent to 85.5 tons as substitution with cheaper materials continues to affect demand. After an impressive first quarter that saw ETF turning positive for the first time since the fourth quarter of 2012, ETF net flow was nil in the second quarter.

Overall investment demand dipped 11 percent to 178.5 tons due to three factors: directionless gold prices, inflows into risky assets such as equities and U.S interest rate hike expectations. Total bar and coin demand plunged 15 percent year over year to 201 tons. In Europe, demand for both bars and coins went up and ETFs saw an inflow helped by the Greek crisis. 

The Central banks remained the primary acquirers of gold, purchasing net 137 tons over the quarter. This accumulation of gold reserves continues to be diversification, namely away from the US dollar. Russia retained its appetite for gold and claimed the top position, followed by Jordan and Kazakhstan. 

Overall Supply Dips Despite Rise in Mine Production 

Mine production in the second quarter grew three percent to 787 tons, with growth across the board as mines in a number of countries generated minor increases in output. The major contribution was from Indonesia. Mining entered a high-grade area at Newmont Mining's Batu Hijau mine, accounting for around five tons of additional year-over-year output. Freeport-McMoRan Inc.'s Grasberg mine, which is the largest gold mine, also generated a modest increase, adding 2.5 tons. 

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Increased output at both Barrick Gold's Goldstrike and Newmont's Twin Creeks mines also contributed to the growth in the U.S. In Africa, continued ramp up of Randgold Resource Limited's Kibali mine in the Democratic Republic of Congo and the start of B2Gold Corp.'s Otjikoto in Namibia led to the increase. On the other hand, production in Ghana declined year on year due to lower output at Newmont's Ahafo mine. 

Recycling of gold dipped eight percent year over year to 251 tons as supply from U.S consumers dried. Hence, overall gold supply dipped five percent year over year to 1,032.6 tons in the quarter as rise in mine production was offset by shrinking recycling volumes. 

Sector Level Earnings Trend 

Within the Zacks Industry classification, the gold mining industry falls under the broader Basic Materials sector (one of the 16 Zacks sectors). The sector reported a 3.7 percent year-over-year increase in earnings in the second quarter. The third-quarter earnings season has just taken off and only 4.8 percent of the companies in the sector have come out with their numbers, putting up a 35.2 percent decline in earnings on the scoreboard. 

Taking into account the other companies that are yet to report their results, the earnings graph is expected to take a nosedive from the 3.7 percent increase in the second quarter to a 21.6 percent decline in the third quarter. In the fourth quarter, it is expected to somewhat recover but still remain in the negative territory with a 12.6 percent drop. 

The scenario nevertheless will improve next year, making its headway in the positive territory and then resume its upward course. An increase of 2.5 percent is expected in the first quarter, which will subsequently rise to 3.6 percent in the second and 23 percent in the third quarter. 

Industry Ranking & Outlook - Neutral 

We rank all of the more than 257 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available on the Zacks Industry Rank page . 

The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 257+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #86 and lower) is positive, the middle one-third (between #87 and #172) is neutral while the outlook for the bottom one-third (Rank #173 and higher) is negative. 

Currently, the gold mining industry is featured in the middle tier with a Zacks Industry Rank of #113, indicating a neutral outlook. 

What to Expect? 

A delay in raising interest rates elevates demand for gold which produces no income but relies on price appreciation to attract investors. The upcoming October FOMC (Federal Open Market Committee) policy meeting will shed some light on when investors can finally expect the rate hike. 

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Gold prices will get support from retail demand for gold, particularly with India and China entering a seasonally stronger part of the year. Demand remains strong during the Diwali festival and wedding season in India, and Thanksgiving, Hanukkah, Christmas and New Year's in the U.S. India is currently the world's top gold consumer and lower prices, easing of import norms, better prospects for economic growth exhibit an encouraging backdrop for gold demand in India. Central bank demand will also support prices as demand from this sector has been remarkably consistent. 

Given the dearth of new projects, mine production will slow down in the next couple of years. Lower gold prices compared with previous years and cost pressures have restricted the ability of gold producers to invest in new projects in recent years. This could eventually lead to a supply crunch that would support prices. Neutral outlook for the time being with expectations of positive earnings growth eventually in 2016 makes a good case for the gold mining industry. 

Previously posted on Zacks.comThe views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Mining Global.

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