“The 2013 Gold Crash”“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” - Warren Buffett
The legendary investor is known for his antagonistic take on gold as an investment option. But there is no denying the unmatched popularity of the yellow metal from historical times given its sheen and value. Investors have bought gold as a hedge against inflation or a safeguard against the collapse of paper assets.
Gold ETFs (Exchange Traded Funds) have also become very popular as an investment option. Gold’s attributes like malleability, resistance to corrosion or tarnishing, and shine make it ideal for jewelry. And so long as vanity exists, can jewelry ever go out of fashion?
However, gold has lately fallen from grace as an investment option. The words of Buffet never rang so true.
The “Golden” Days
The global financial crisis of 2008 severely hit investors’ confidence in conventional paper assets, making gold an attractive alternative. This led gold prices soaring to an all time high of $1,900 per ounce in Aug 2011. In 2012, gold’s average market price of $1,669 per ounce hit an all-time record high, taking advantage of a weak dollar, lingering concerns over Europe’s financial problems, China’s reduced economic growth numbers and announcement of the third round of quantitative easing (QE3).
2013: A Nightmare Year for Gold
Highlights: Alarming Drop in April; Lowest Price in Three Years in June and Came Close in December, Ends 2013 at around $1,200 per ounce
2013 was an unlucky year for gold as it suffered a 28% drop, ending the year at around $1,200 per ounce – the worst slump in more than three decades. It was not one event that affected the gold market in 2013. A multitude of factors – the Federal Reserve’s taper or no taper confusion, conflict in Syria and the U.S. government‘s partial shutdown, and finally the taper call at year end – pushed gold prices downhill through the year.
Gold plunged 9% in one day to $1,395 per ounce on Apr 12 – the biggest loss in one day -- on the news that Cyprus would sell gold from its reserves. This led investors to offload their positions. In June, reports that the Fed was contemplating tapering its $85 billion of bond purchases sent gold prices reeling to the 2013 nadir of $1,192 per ounce on Jun 28 – the level last seen in Aug 2010.
In late August, gold prices trended higher as it regained its status as a safe investment hedge amid fears surrounding a possible U.S.-led military attack on Syria. As the military intervention in Syria was avoided, traders offloaded their positions, leading to a subsequent drop in September. The Federal Reserve’s unexpected announcement on Sep 18 that it will not taper resulted in a 5% surge in a day on Sep 19, marking the maximum gain for the year.
However, gold prices again continued to fall during the U.S Government shutdown. This confused gold traders as it did not drive safe-haven bids as normally expected. Finally, the Fed’s announcement of a $10 billion cut in its monthly bond purchases on Dec 18 prompted a huge sell-off which pushed gold prices down to $1,105 per ounce, the strongest negative reaction for gold since June. Gold exited 2013 at around $1,200 per ounce.
As per the latest published data from the World Gold Council, total gold demand in the first three quarters of 2013 declined 12% to 4,373 tons, as substantial net outflow from gold ETFs offset demand for jewelry, bars and coins. Jewelry demand soared 20% and demand for gold bars and coins also went up 36% year over year, mainly driven by China and India. Jewelry demand in the U.S. has been strong over the first three quarters of 2013 after a gap of eight years, fueled by positive signs of a recovery and lower prices.
Central banks remained the primary purchasers of gold, albeit at a slower rate, purchasing net 297 tons in the period, accounting for around 9% of total gold demand. On the contrary, the first three quarters of 2013 witnessed a 697 tons net outflow from gold ETFs. The major impact was felt in the second quarter with a record outflow of 402 tons as gold prices fell sharply.
The difference between investors at the retail and the investment level was never so apparent. Retail investors (in gold bars and coins) view gold for preserving wealth and hedging against inflation over the long term. Thus, in 2013, demand from retail investors leaped to unprecedented levels as they saw an opportunity to add to their holdings as gold prices dipped.
On the other hand, the institutional investors have a short-term, speculative approach. Expectations of the U.S. government tapering quantitative easing led to ETF investors losing confidence in gold as a safe haven. The price drop prompted opportunistic investors to sell their ETF holdings and shift to other investment options. During the year, the U.S. stock market was on fire and investors flocked to equities shunning gold.
Mine production in the first three quarters was at 2,188 tons, up 3% year over year. This is a marked improvement, as production in 2012 was restrained by labor disruptions, operational issues, delayed project start-ups and expansions. China topped the list followed by Dominican Republic, Brazil, Canada and Australia.
Recycling of gold contributed 1,047 tons to the total supply, 13% lower year over year. The drop in gold prices led to a decline in recycling activity as consumers are less inclined to part with their stocks at lower prices. Recycling activity has declined in the past six consecutive quarters. Overall, gold supply dipped 4% to 3,196 tons in the first three quarters of 2013, dragged down by lower recycling activity.
The gold companies are yet to announce their fourth quarter results. As we delve into the September-end quarterly numbers of the gold companies in our coverage -- Barrick Gold Corporation (ABX - Analyst Report), Harmony Gold Mining Company Limited (HMY - Analyst Report), Newmont Mining Corporation (NEM - Analyst Report), Kinross Gold Corporation (KGC - Analyst Report), Agnico Eagle Mines Limited (AEM - Analyst Report) and Goldcorp Inc. (GG - Analyst Report) -- we see earnings have taken a beating across the board due to the decline in average realized gold prices.
The price decline added to the woes of the industry that was already grappling with rising costs, labor issues, strikes, delays and/or the cancellation of projects. If prices fall further, margins will be constrained as the price of gold closes in on the cost per ounce of the companies.
The gold miners have decided to suspend projects, curtail their capital spending and resort to layoffs to conserve cash. The companies are actively pursuing opportunities to optimize their portfolio, including the divestiture of certain non-core or non productive assets.
Following the sale of its oil and gas unit, Barrick Energy, and three Australian mines last year, Barrick Gold announced its plans to divest the Plutonic mine and Kanowna gold mine in Western Australia over the past two months. Likewise, Newmont has entered into a deal to sell its Midas underground operation and mill complex in Nevada.
In Feb 2014, Goldcorp along with its joint venture partner Barrick Gold announced that they will sell their respective stakes in Marigold mine in Nevada. Barrick and Newmont have resorted to dividend cuts while Kinross and Harmony Gold have suspended their dividend payouts.
The austerity in the mining sector has led to more measured mergers and acquisitions (M&A). Companies have slowed down M&A deals since last year, but Chinese gold miners remained active on the acquisition front.
To capitalize on the strong domestic demand for gold, Chinese companies are boosting their gold resource base by acquiring overseas as well as domestic gold mines. Lower gold prices seemed to be the triggering force behind the deals as the companies were able to acquire assets at discounted prices.
One surprising development came in Jan 2014 as Goldcorp announced its plans to acquire Osisko Mining Corporation for about C$2.6 billion ($2.4 billion). Following the completion of the construction of its key growth projects at Cerro Negro, Eleonore and Cochenour over the next 18 months; this deal will make Goldcorp the largest gold producer in the Eastern Canadian province.
It is clear that M&A activity in the mining industry is expected to remain slow. Deals will come through only when companies have enough cash to seize the opportunity to takeover assets unloaded by peers. It remains to be seen whether Goldcorp’s takeover bid of Osisko Mining could lead to a fresh round of M&As in an otherwise a dormant market.
Industry Ranking & Outlook – Negative
Within the Zacks Industry classification, the gold industry falls under the broader Basic Materials sector (one of 16 Zacks sectors). We rank all of the more than 260 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available in the Zacks Industry Rank page.
The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 260+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #87 and lower) is positive, while the outlook for the bottom one-third (Zacks Industry Rank #174 and higher) is negative. Currently, the gold mining industry is featured in the lowest tier with a Zacks Industry Rank of #201, indicating a bearish outlook.
Please note that the Zacks Rank for stocks, which are at the core of our Industry Outlook, has an impressive track record, verified by outside auditors, to foretell stock prices, particularly over the short term (1 to 3 months). The rank, along with Earnings ESP, helps to predict the probability of earnings surprises.
Performance in the Sector
In the Basic Material sector, earnings increased 2.2% in the third quarter of 2013. We are in the final phase of the fourth quarter earnings season. 75% of the companies in the sector have already reported their financial results. Earnings increased 43.9% while revenues edged up 2%. On the basis of the reported numbers, the Basic Material sector has a beat ratio (percentage of companies coming out with positive surprises) of 77.8%.
Q4 & Beyond
Taking into account all the companies yet to report fourth-quarter results, earnings of the Basic Material sector are expected to increase 20.5% in the quarter. For 2014, earnings at the sector are expected to grow at a rate of 2.5% in Q1, then 2.1% in Q2 and 1.6% in Q3. Overall, in 2014, the sector’s earnings are projected to grow 3%. In 2015, the growth will go up to 4.3%.
What Lies Ahead?
So far in 2014, gold prices have ranged from $1,221 per ounce to $1,267 per ounce, averaging $1,247 per ounce to date. The Fed’s announcement on Jan 29 to reduce asset purchases by another $10 billion a month to $65 billion kept the prices in check.
However, over the last week, gold prices rose 1.9% following dull economic numbers from the U.S. including lower manufacturing PMI and the economy adding only 113K jobs in January, well below expectations. Chinese buyers returned after a week-long holiday, providing support to the prices.
Analysts continue to see rough days ahead for gold. They have cut down their estimates for 2014, and their price expectation ranges from as low as $1,057 per ounce to $1,292 per ounce.
The decline in prices has dealt a severe blow to investor confidence for gold which might take many a month to restore. Even though it has resulted in major losses in the paper gold market, it has otherwise triggered a gold rush for the actual physical metal in the form of bullion, jewelry, bars and coins. Thus, gold prices will get support from retail demand for gold, particularly in India and China.
With the tapering in the quantitative easing program set to reduce investible surplus in consumers’ hands, gold prices will remain under pressure in 2014. Easy liquidity was the driver for increase in gold prices over the past decade.
The positive sentiment in equity markets will lure investors from safe haven investments like gold for the time being. Thus, the future of gold hinges on market sentiment, the U.S economy’s progress, the Fed’s policy and the demand for gold in Asia.
Admittedly investors have fled the mining sector and two things need to happen before investors regain interest in gold mining stocks: (1) gold price needs to rise and (2) the industry needs to rebuild its credibility by delivering on promises of greater shareholder returns. The consumers who rushed in to buy gold following the fall in prices might have to wait patiently for their anticipated returns to materialize.