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Though 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, it has a number of threats lurking. Below, we discuss some of the key challenges and what investors in the sector can look forward to in the coming months and years.
Slowdown in China
China’s economy grew at an annual rate of 6.9% in the first quarter of 2017, a tad better than the 6.8% growth witnessed in the fourth quarter. For 2017, the Chinese government projects growth figure of 6.5% compared with the 6.7% expansion in 2016, which is the slowest growth in 26 years.
While rebalancing progresses, the Chinese economy continues to slow. 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. Jewelry demand in China 2016 slumped 17% due to higher gold prices. Demand in China will remain constrained in the short term. Gold jewelry demand has been negatively affected by the slowing economic environment as well as changing consumer tastes. It has been observed that the younger Chinese consumers want to spend their money on experiences rather than material goods.
Production at Risk
As per the World Gold Council, mined production has already reached a plateau and it is a matter of time before it goes downward. Over the next five to 10 years, the production profile of currently operating mines shows a relatively steep drop.
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 slowing down in the growth rates. This has made further production gains increasingly difficult.
This is the aftermath of sharp cuts in capital expenditures in recent years as well as the lack of significant discoveries. Though there have been signs of renewed interest in brownfield development and extending the life of existing mines, these are not adequate to mitigate the slashed project development spending. As existing reserves are depleted, the current project pipeline will be inadequate to replace them fully, and ultimately there will be a supply crunch.
Some gold companies, including Barrick Gold Corp. , Goldcorp, Inc. and Newmont Mining Corp. (NEM - Free Report) 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 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 - Free Report) and Agnico Eagle Mines Ltd. (AEM - Free Report) have slashed capital and exploration spending.
Gold Substitutes in Technology
Demand for gold in technological applications is affected by sluggish economic conditions in key markets and substitutes being found. 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.
The Federal Reserve hiked rates for the third time since the Great Recession in March, in a widely expected move that reflects confidence in the strength of the economy. Fed Chair Janet Yellen and her colleagues lifted a key interest rate for the second time in three months.
Citing an improving labor market and greater confidence in consumers, the Fed raised federal funds rate to a range of 0.75% to 1%. The policy rate rose by 25 basis points to 1% for the first time in a decade. The Fed has signaled two more rate hikes by the end of the year.
Inherent Risks
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 is likely to more than neutralize 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 unfavorable Zacks Rank. The other metrics also indicate that they are not profitable investment options at present.
Alamos Gold Inc. (AGI - Free Report) currently carries a Zacks Rank #4 (Sell). In the trailing four quarters, the company posted an average negative earnings surprise of 137.50%. The 2017 earnings estimates for Alamos Gold have gone down by 7% in the last 30 days and for 2018 have plunged 50%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Eldorado Gold Corp. (EGO - Free Report) , another Zacks Rank #4 stock has witnessed a 20% drop in estimates. The company delivered a negative average earnings surprise of 13.89% in the trailing four quarters.
Pershing Gold Corp. carries a Zacks Rank #4. The Zacks Consensus Estimate for 2017 is at loss of 24 cents per share. The estimates for 2017 have aggravated from a loss of 12 cents to 24 cents per share in the last 60 days. The company has a negative average earnings surprise of 1.18% in the preceding four quarters.
Bottom Line
Dwindling production, lack of new projects 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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Will the Gold Industry Reel Under Headwinds?
Though 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, it has a number of threats lurking. Below, we discuss some of the key challenges and what investors in the sector can look forward to in the coming months and years.
Slowdown in China
China’s economy grew at an annual rate of 6.9% in the first quarter of 2017, a tad better than the 6.8% growth witnessed in the fourth quarter. For 2017, the Chinese government projects growth figure of 6.5% compared with the 6.7% expansion in 2016, which is the slowest growth in 26 years.
While rebalancing progresses, the Chinese economy continues to slow. 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. Jewelry demand in China 2016 slumped 17% due to higher gold prices. Demand in China will remain constrained in the short term. Gold jewelry demand has been negatively affected by the slowing economic environment as well as changing consumer tastes. It has been observed that the younger Chinese consumers want to spend their money on experiences rather than material goods.
Production at Risk
As per the World Gold Council, mined production has already reached a plateau and it is a matter of time before it goes downward. Over the next five to 10 years, the production profile of currently operating mines shows a relatively steep drop.
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 slowing down in the growth rates. This has made further production gains increasingly difficult.
This is the aftermath of sharp cuts in capital expenditures in recent years as well as the lack of significant discoveries. Though there have been signs of renewed interest in brownfield development and extending the life of existing mines, these are not adequate to mitigate the slashed project development spending. As existing reserves are depleted, the current project pipeline will be inadequate to replace them fully, and ultimately there will be a supply crunch.
Some gold companies, including Barrick Gold Corp. , Goldcorp, Inc. and Newmont Mining Corp. (NEM - Free Report) 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 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 - Free Report) and Agnico Eagle Mines Ltd. (AEM - Free Report) have slashed capital and exploration spending.
Gold Substitutes in Technology
Demand for gold in technological applications is affected by sluggish economic conditions in key markets and substitutes being found. 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.
The Federal Reserve hiked rates for the third time since the Great Recession in March, in a widely expected move that reflects confidence in the strength of the economy. Fed Chair Janet Yellen and her colleagues lifted a key interest rate for the second time in three months.
Citing an improving labor market and greater confidence in consumers, the Fed raised federal funds rate to a range of 0.75% to 1%. The policy rate rose by 25 basis points to 1% for the first time in a decade. The Fed has signaled two more rate hikes by the end of the year.
Inherent Risks
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 is likely to more than neutralize 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 unfavorable Zacks Rank. The other metrics also indicate that they are not profitable investment options at present.
Alamos Gold Inc. (AGI - Free Report) currently carries a Zacks Rank #4 (Sell). In the trailing four quarters, the company posted an average negative earnings surprise of 137.50%. The 2017 earnings estimates for Alamos Gold have gone down by 7% in the last 30 days and for 2018 have plunged 50%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Eldorado Gold Corp. (EGO - Free Report) , another Zacks Rank #4 stock has witnessed a 20% drop in estimates. The company delivered a negative average earnings surprise of 13.89% in the trailing four quarters.
Pershing Gold Corp. carries a Zacks Rank #4. The Zacks Consensus Estimate for 2017 is at loss of 24 cents per share. The estimates for 2017 have aggravated from a loss of 12 cents to 24 cents per share in the last 60 days. The company has a negative average earnings surprise of 1.18% in the preceding four quarters.
Bottom Line
Dwindling production, lack of new projects 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.
Looking for Stocks with Skyrocketing Upside?
Zacks has just released a Special Report on the booming investment opportunities of legal marijuana.
Ignited by new referendums and legislation, this industry is expected to blast from an already robust $6.7 billion to $20.2 billion in 2021. Early investors stand to make a killing, but you have to be ready to act and know just where to look. See the pot trades we're targeting>>