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Industry Outlook

At the onset of 2014, gold investors enjoyed some respite after a nightmarish 2013, in which it lost 28% of its value with everything going against it. However, concerns about the economy and geopolitical tensions boosted its safe haven appeal in 2014 and acted as catalysts for its value. Nevertheless, of late, a stronger US dollar has again tainted the precious metal's grandeur and toppled its price. Further, demand has been weak in its biggest markets –China and India.
 
Fluctuating Prices in 2014 So Far
 
Gold has had its fair share of ups and downs in 2014, but prices remained in the range of $1,202 to $1,380 per ounce. After hovering on either side of $1,300 in the second quarter, gold prices plummeted to $1,244 per ounce in the first week of June as positive U.S. economic indicators boosted the dollar and pushed gold prices in the opposite direction. Gold’s safe-haven status during the times of turmoil was tarnished by the waning concerns about Ukraine. Furthermore, lower demand in China as well as India, in contrast to the record levels last year, also kept prices at check.
 
Prices regained ground and hit a 3-month high of $1,339 on Jul 10, driven by mounting tensions over Ukraine and Gaza. During most of July, prices remained above $1,300 an ounce but at month-end, prices went down as the US economy picked up steam with stronger-than-expected GDP growth of 4%. In early August, gold prices steadied with the effects of economic data and geopolitical developments appearing to counterbalance each other.
 
In September, prices remained steadfastly under the $1300 range. As the dollar rose to four-year highs against a basket of currencies and stock markets strengthened, gold prices fell to a nine-month low of $1,207 per ounce on Sep 25. Shares of gold miners, Barrick Gold Corporation (ABX - Analyst Report), Alamos Gold Inc. (AGI - Snapshot Report), Yamana Gold, Inc. (AUY - Snapshot Report), IAMGOLD Corp. (IAG - Snapshot Report) and Harmony Gold Mining Company Ltd. (HMY - Analyst Report) all took a beating and hit 52-week lows on Sep 25. However, gold rebounded sharply from the nine-month low as sell-off in U.S. equities prompted investors to buy bullion as a mode of security.
 
However, these gains might not be long-lasting. As the U.S. economy continues to improve, the dollar will rally, which is not conducive for gold. In the balance of 2014, factors that could work in gold's favor are better-than-expected buying in India due to the upcoming traditional gold-buying festival and wedding season, and a return to safe-haven buying if the situation in Middle East worsens.
 
Gold Demand Weaker in Q2
 
As per the World Gold Council, total gold demand in the second quarter of 2014 was weaker year over year, declining 16% to 964 tons, as the quarter was pitted against remarkable demand levels witnessed in the prior-year quarter, which benefitted from the 25% drop in gold prices in contrast to the range bound prices this quarter.
 
Jewelry demand ended its bullish run for seven consecutive quarters, with a 20% dip in demand. Asian and Middle-Eastern countries experienced double-digit declines in demand while demand in western markets went up. However, on a positive note, even though jewelry demand in the first half of fiscal 2014 declined compared with the prior year, it has shown an upward trend so far in 2014.
 
In India, ongoing restrictions on gold imports as well as the governmental elections had a dampening effect. With the Reserve Bank of India allowing 5 star trading houses to import gold, it had the instant impact of releasing supply pressure and led to sharp drop in domestic market price premiums. However, the restrictions were no further relaxed, which along with the onset of the seasonally quieter gold buying period, subdued demand in India during the quarter.
 
One of the most noteworthy developments in the quarter was in the investment sector. Overall demand increased 4%, a marked improvement from the substantial decline in the past few quarters. Net ETF outflows in gold were a modest 40 tons in contrast with the 402 tons of outflows witnessed in the year-ago quarter. Bar and coin demand plunged 56% from the record levels last year. The huge purchases of bars and coins made in the previous year created a general reluctance to accumulate those further. Investors also awaited a clearer price trend.

Central banks remained the primary acquirers of gold, albeit at a slower rate, purchasing net 118 tons in the period, accounting for around 12% of total gold demand. In the technology sector, gold demand was down 3% because of a shift to cheaper materials.

In terms of demand, 2013 was an exceptional year, as customers flocked to purchase jewelry, bars and coins as the price went downhill. Thus, in 2014, demand will continue to bear the brunt of unfavorable year-on-year comparisons.
 
Supply Up 10% Due to Growth in Mine Production
 
Mine production in the second quarter of 2014 was at 765 tons, up 4% year over year with new operations coming on stream over the past two years, particularly in Canada and the Dominican Republic and with small-scale additions in a fairly wide range of countries, including Indonesia.
 
Canada stayed atop the leader board with contributions from the new Detour Lake, Canadian Malartic and Young-Davidson and Westwood mines. In the Dominican Republic, production continued to ramp up at the Pueblo Viejo mine, which came on-stream in late 2012.
 
Recycling of gold contributed 263 tons to the total supply, up 1% year over year. Consumers refrained from selling their holdings due to the steady gold price environment. Year to date, supply of recycled gold was at its lowest since the last 7 years mainly due to lower and more stable gold prices, as well as economic recovery in a number of Western markets.
 
Thus, overall gold supply went up 10% to 1,078 tons in the second quarter. The second quarter marked the eighth consecutive quarter of year-over-year growth in mine production, due to pipeline growth and operational measures. We believe this rate of growth will not be sustainable as these operations mature, supply pipeline starts to thin and producers face limited opportunities to impose further cost-cutting measures.

Cost-Cutting is the Key to Survival
 
The historic 28% drop in gold prices in 2013 put the gold mining companies' bottom lines in a tight squeeze. Miners went through a strict round of cost cutting in order to increase profitability by suspending projects, curtailing capital spending and laying off employees.
 
If prices fall further, margins will be constrained as the price of gold closes in on the cost per ounce of the companies. The companies are actively pursuing opportunities to optimize their portfolio, including the divestiture of certain non-core or non-productive assets and reducing debt, maximizing return on capital and driving value across the portfolio.

As part of its continued portfolio optimization actions, Newmont Mining Corporation (NEM - Analyst Report) divested its Jundee underground gold mine in Australia, which underscores its strategy to focus on its core assets that have a longer life and lower cost. Newmont, which recently announced the sale of its 44% stake in the Penmont mine in Mexico, raised $1.3 billion from non-core assets sale since last year. These divestments have improved the company's financial flexibility and placed it in a better position to finance profitable operations.
 
Sector Q2 Earnings Scorecard – Growth Picks Up   

With all the companies in the Basic Material sector having reported their second-quarter results, the curtains have fallen on the season. Earnings increased 8.6% in the quarter on the back of 3.4% increase in revenues. This is a marked an improvement from the first quarter, in which earnings declined 3.8% while revenues inched up 1.2%. For further details on earnings for this sector and others, please read our 'Earnings Trends' report.
 
Q3 & Beyond – Momentum to Continue
 
For 2014, earnings in the sector are expected to grow at a 2.9% rate in the third quarter and 4% in the fourth quarter. In 2014, the sector’s earnings are projected to grow 2%, while in 2015; the growth will accelerate to 5.3%.
 
Industry Ranking & Outlook – Neutral
 
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 on 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, the middle one-third (Zacks Industry Rank between #88 and #173) is 'Neutral' 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 middle tier with a Zacks Industry Rank of #165, indicating a neutral stance.
 
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 the Expected Surprise Prediction (ESP) (Read: Zacks Earnings ESP: A Better Way to Find Earnings Surprises) helps in predicting the probability of earnings surprises.
 
So What Lies Ahead?
 

The austerity in the mining sector led to more measured mergers and acquisitions (M&A). Deals will come through when companies have enough cash to seize the opportunity to take over assets unloaded by peers. The acquisition of juniors, most notably of Volta Resources by B2Gold, Brigus Gold by Primero, and Agnico Eagle Mines Limited (AEM - Analyst Report) and Yamana Gold’s acquisition of Osisko Mining could lead to a fresh round of M&As in an otherwise dormant market.
 
Gold will eventually bounce back from the lows as buying in Asia traditionally increases during this time of the year. Top bullion consumer China has been importing more gold in September to meet the demand from retailers stocking up for the upcoming National Day holiday. India, the second largest consumer will also follow suit with the upcoming festival and wedding season. Recent official trade data shows a 176% rise in gold imports in India during August.
 
Even though strength in the U.S. and European equity markets will distract gold investors, gold prices will get support from retail demand for gold, particularly in India and China. Central bank demand will also support prices as demand from this sector has been remarkably consistent. Moreover, geopolitical tensions will spur safe-haven buying.

Production pullbacks in response to lower gold prices last year and mining development delays could eventually lead to a supply crunch which would support prices. A neutral Zacks Rank and projected earnings growth for 2014 makes a good case for the gold mining industry.

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