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Industry Outlook

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 is saddled with a number of headwinds. Below, we discuss some of the key challenges and what investors in the sector can look forward to in the coming months and years.

Lack of New Projects, Production to Flatten

Annual mine production grew for the sixth straight year in 2014, edging up 2% to a record 3,114.4 tons. However, after a long period of growth, gold production dipped by 1% in the third quarter of 2015. While output is slowing down from older mines, particularly in South Africa and the U.S., it is in contrast to the incremental impact on production from new mines coming on stream.

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 and thus growth rates are slowing down, making 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 favorable 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 - Analyst Report), Goldcorp, Inc. (GG - Analyst Report) and Newmont Mining Corp. (NEM - Analyst 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 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 and Agnico Eagle Mines Ltd. (AEM - Analyst Report) 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.

Restricted Margins

The price decline added to the woes of an industry that was already fighting 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. In the wake of falling prices, the industry would see a rise in the number of producers reducing output or even shutting down operations.

Companies are collaborating with other miners to help recoup previous losses. However, costs are difficult to curtail beyond a point, so miners will only profit if gold prices rise in response to demand and other macroeconomic factors. Production cutbacks and mine closures would spell more financial pain for producers and investors, who have watched gold mining stocks slump.

Gold Substitutes in the Technology Sector

Demand for gold in technological applications dipped 1% year to date, 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.

As per the last data by the World Gold Council, gold witnessed a decline of 4% in dental demand in the third quarter of 2015, the worst performance on record. 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.

Recycling to Remain Low

In the third quarter of 2015, recycling declined 6% to 268 tons, the lowest quarterly figure since 2008. Diminished recycling levels in western markets were dominated by consumer behavior in North America, as the fall in the gold price, coupled with a gradually improving economy, reduced the incentive to sell gold. Recycling activity will remain low and may deteriorate further given that a large portion of near-market supply has been flushed out in recent years. Less distress selling may further suppress recycling volumes. Many collectors are struggling to source feed stock.

Inverse Relation Between Rising U.S. Dollar and Gold Prices

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 in the U.S, it will again put gold prices under pressure.

Cheaper oil means lower inflation. This indicates that gold would be impacted negatively as it is usually considered a hedge against inflation. Low U.S. inflation is damaging for gold stocks such as Goldcorp, Barrick Gold, Newmont Mining and Kinross Gold Corp. (KGC - Analyst Report).

Inherent Risks in the Industry

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 the mine development project is successful, returns can be enormously high, which more than offsets the risks and the capital invested.

Bottom Line

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 shaping up for this sector going forward.

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