Demand for gold will remain strong in the years to come given the demand for jewelry, bars and coins as well as its safe-haven appeal. Yet, the gold mining industry has a number of lurking headwinds. Below, we have discussed some of the key challenges and what investors in the sector can look forward to in the coming months and years.
China's stock market has been shaken by the slowdown in the country's economy. China's economy grew at an annual rate of 6.7% in the second quarter, the slowest quarterly growth in seven years. The Chinese government is targeting for growth of 6.5 to 7% in 2016, a slower pace than what it had got accustomed to in the past two decades.
The International Monetary Fund (IMF) projects 6.6% growth in China in 2016. In China, policymakers continue to shift the economy away from its reliance on investment and industry toward consumption and services. This is anticipated to slow growth in the short term while building the foundations for a more sustainable long-term expansion.
The continued general economic slowdown has had a negative impact on customer sentiment. Demand in the second quarter slumped 15% to 143.5 tons, taking the first half total to 322.5 tons, the lowest first half total for Chinese jewelry since 2012. Moreover, changing consumer preferences is also impacting volumes as a growing younger customer base opting for fashionable, unique, highly-designed 18k or gem-set pieces rather than traditional 24k jewelry.
Production to Flatten on Lack of New Projects
Mine production in 2015 saw its first quarterly decline and its slowest annual growth rate since 2008. While output is slowing down from older mines, particularly in South Africa and the U.S., the incremental impact on production from new mines coming on stream is gradually on the ebb. Previously, incremental production from newer mines led to continued growth in overall gold production. However, newer mines are now at or near their full potential, leading to a slowing down in the growth rates. This has made further production gains increasingly difficult.
After a period of implementing cuts to spending on capital and administration, much of the recent cost reduction has come from lower oil prices and favourable exchange rate moves. Reduced spending on exploration and development has already taken its toll on the production pipeline and will further squeeze production over the coming quarters.
Some gold companies, including Barrick Gold Corp. (ABX), Goldcorp, Inc. (GG) and Newmont Mining Corp. (NEM) are currently high-grading at certain mines. The high-grade portion of a mine is mined first as this increases the grade of the mined ore and lowers cost per unit.
However, it has its pitfalls as it depletes reserves very quickly, thus affecting long-term supply. Gold miners, grappling with low gold prices and cost pressure, have not been in a position to invest in new projects in recent years. Companies including AngloGold Ashanti Ltd (AU) and Agnico Eagle Mines Limited (AEM) have slashed capital and exploration spending. Given the lack of new projects, mine production will eventually reach a plateau in the next couple of years.
Gold Substitutes in Technology
Demand for gold in technological applications is affected by sluggish economic conditions in key markets and substitutes found for the metal. Despite inferior durability, copper and palladium-coated copper have made vast inroads into the share of gold in the bonding wire sector. The decade-long decline in the dental sector shows no sign of abatement as gold continues to lose ground to ceramic alternatives, which have improved steadily in quality, strength and durability.
Impact of a Stronger Greenback, Rate Hike
There is an inverse relationship between the trade-weighted U.S. dollar and the price of gold. If the dollar gains strength against major currencies on the back of positive macroeconomic data, like an improving job market and growing industrial activity, it will again put gold prices under pressure.
Lately better than expected economic data has increased the speculation that the FED will raise interest rates by December. This led to a climb in US dollar to two months high and consequently gold dipped below $1,300 an ounce. Additionally pushing down gold is the dollar's rise against the British pound, which slumped to a 31-year low against the dollar after the release of a timeline for Britain's exit from the European Union.
Gold exploration and mining are time consuming and expensive tasks. Given its scarcity and remote location of deposits, exploration for new gold deposits is difficult. Once an economically viable deposit is identified, bringing a mine on line can take a decade or more, and it requires substantial capital investment.
Moreover, the mining industry is subject to several risks such as political conflicts, environmental hazards, industrial accidents, unexpected geological conditions, labor force disruptions, unavailability of materials and equipment, weather conditions, pit wall failures, rock bursts, cave-ins, flooding, seismic activity and water conditions. However, once a mine is successfully developed, its returns can be enormously high. This will more than offset the risks inherent in development and the capital invested for the project.
Gold Stocks to Avoid for the Time Being
We presently recommend investors to stay away from the following gold stocks as they presently have an unfavourable Zacks Rank. The other metrics also indicate that they are not profitable investment options at present.
Alamos Gold, Inc. (AGI) currently has a Zacks Rank #4 (Sell). The average negative surprise for the last four quarters is 103.22%. The 2016 earnings estimates have gone down by 42% in the last 60 days.
Harmony Gold Mining Company Ltd. (HMY) currently has a Zacks Rank #4. The 2016 earnings estimates have gone down by 7% in the last 60 days.
AngloGold Ashanti Ltd. (AU) carries a Zacks Rank #5 (Strong Sell). The average negative surprise for the last four quarters is 360%.
Earnings estimates for Pretium Resources Inc. (PVG) have gone down over the last 60 days. The Zacks Consensus Estimate for 2016 is at a loss per share of 22 cents. The company currently has a Zacks Rank #4. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Dwindling production, lack of new projects and decline in recycling activity and the constant threat of a stronger greenback are some of the sector’s worst detractors. But what about investing in the space right now -- are there opportunities for short-term investors overriding the headwinds?
Check out our latest Gold Mining Outlook for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.
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PRETIUM RES INC (PVG): Free Stock Analysis Report
NEWMONT MINING (NEM): Free Stock Analysis Report
HARMONY GOLD (HMY): Free Stock Analysis Report
GOLDCORP INC (GG): Free Stock Analysis Report
ANGLOGOLD LTD (AU): Free Stock Analysis Report
ALAMOS GOLD INC (AGI): Free Stock Analysis Report
AGNICO EAGLE (AEM): Free Stock Analysis Report
BARRICK GOLD CP (ABX): Free Stock Analysis Report
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