Gold has exhibited a bullish run in the markets so far this year. The yellow metal’s safe haven appeal was evident from its gain of 14%, riding on the back of a weaker dollar, terrorist attacks in the U.K. and escalating tensions between the United States and North Korea. In fact, the precious metal broke the threshold limit of $1,300 an ounce this year.
Further, uncertainty over the economic agenda of President Trump and mounting speculation on whether the Fed will deliver a third rate hike this year has fueled the price rise. Concerns over the aftermath of Hurricanes Harvey and Irma led to some safe haven buying as well.
Demand Dips in the First Half, India Holds Ground
Per the data available from the World Gold Council, global gold demand in the first half of 2017 was at 2,003.8 tons, a 14% decline year over year. The decline can primarily be attributed to the slowing down of ETFs from the record levels last year.
Jewelry demand grew 5% year over year to 967.4 tons, remaining persistently below the 1,000 ton mark. India was the main driver of demand as the market stockpiled gold ahead of the implementation of GST (Goods and Service Tax). Sales also escalated with festival and weddings related buying and improved rural sentiment. Meanwhile, demand in China in the first half was 4% below prior-year levels reflecting customer shift from pure 24k gold to lower-carat gold jewelry, which remained the dominant trend.
Technology demand registered its third consecutive quarter of growth in the second quarter. Gold used in technology rose 2% year over year, driven by growth in demand for bonding wire, Printed Circuit Boards (PCBs) and LEDs, particularly in the automotive sector.
Investment in gold bars and coins improved 11% year over year, from exceptionally weak demand last year. China and India were primary catalysts.
Central banks purchased 94.5 tons in the second quarter, 20% rise year over year. This brought the total in first half to 176.7 tons, down 3% year over year. One major development in the second quarter was Turkey buying 21 tons — its first significant addition to reserves since the 1980s.
ETF Inflows Slowed Down
Compared with the last year’s record pace, ETF inflows have slowed. In the first half of 2017, inflows reached 167.9 tons. Europe mainly drove the ETF market in 2017, accounting for 76% of inflows in the first half.
The three main factors that influenced investor attitudes toward gold ETFs were — monetary policy normalization, gold price and event risk. The prospect of continued monetary tightening dampened ETF demand. Rising interest rates are usually considered as negative for gold.
Higher gold prices led to some investors taking a more cautious approach. Event risk, particularly surrounding geopolitical tension, remained a key driver of demand for ETFs. Frequent global terrorist incidents, tension between the United States and North Korea added to the inflows.
Supply Growth in the Red: A Signal of Caution?
Mine Production was flat at 1,557 tons in the first half. In the second quarter, mine production was pegged at 791.2 tons, the lowest second quarter since 2014. Production in China dipped 8% due to more stringent environmental regulations. In Tanzania, an ongoing dispute between the government and Acacia Mining led to 20% plunge in production. Production in Mongolia declined 30% year over year, as Oyu Tolgoi continues through a planned phase of low grading.
In Indonesia, the resumption of concentrate exports from Freeport-McMoRan Inc. (FCX - Free Report) operated Grasberg mine led to 30% rise in gold production. In Suriname, the continued ramp up of Newmont Mining Corp.'s (NEM - Free Report) Merian gold mine helped output surge by 80% year over year. In Canada, second-quarter output rose by 8% year over year, partly due to the start-up of the Hope Bay and Brucejack mines.
Sector Level Earnings Trend
Per the Zacks classification, the gold-mining industry comes under the broader Basic Materials sector. The sector’s earnings rose 7% in the second quarter, a deceleration from growth of 13.5% witnessed in first-quarter 2017. Even though the sector’s earnings will decline 11.2% in the third quarter, growth will resume with a projected 9.1% rise in earnings for the fourth quarter. (For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)
Industry Ranking – Negative
The Zacks Industry Rank relies on the same estimate revisions methodology that drives the Zacks Rank for stocks. The way to look at the complete list of industries is that, we put our X industries (all 265 of them) into two groups: the top half (i.e., industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank).
In the last 10 years, using a one-week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. Click here to know more: About Zacks Industry Rank
Within the Zacks Industry classification, the gold mining industry is grouped under the Basic Materials sector (one of 16 Zacks sectors). The gold mining industry occupies a space in the bottom half of the Zacks classified industries with a Rank of #172.
Improved Price Performance, Attractive Valuation
Year to date, the Zacks Gold Mining industry has gained 13.0%, outperforming the S&P 500’s advance of 11.9%.
Going by the EV/EBITDA multiple (a preferred valuation metric for mining companies that have high capital expenditures), the gold mining industry has a trailing 12-month EV/EBITDA multipleof 7.55, lower than the S&P 500 EV/EBITDA multiple of 11.09.
Where Is the Industry Headed?
In the United States, even though there are positive expectations about President Trump’s economic proposals, there are also concerns. Further, the United States-North Korea imbroglio has turned the tables this year for gold. Mounting fears regarding what’s next — negotiation or war — works in favor of gold which is considered a good store of value during political turmoil.
Macroeconomic trends in Asia will support economic growth in the coming years. Given that gold demand is generally closely correlated to increasing wealth in the continent, gold demand will increase in tandem. In Asia, gold demand is mainly retail demand for the metal, due to festival and wedding related buying activities in countries like India and China.
While demand will remain strong, supply of this precious metal has already attained peak levels as per reports. Despite major miners improving cash flow and cutting debt in the last few years, project capital expenditure remains at multi-year lows.
There are a few new projects and expansions anticipated to commence production this year. Further, those in the near-term pipeline are generally fairly modest in scale. Per the World Gold Council, the project pipeline will experience a small pick-up in 2017 and 2018 before global mine production levels begin to decline in 2019. The combination of lower mined gold supply and higher demand could eventually propel the prices north.
How to Play the Industry
Despite a low ranking now, improved performance compared with the S&P 500, low valuation and earnings growth expectation makes a good investment case for the gold mining industry. Investors can consider the following gold stocks that are backed by a solid Zacks Rank.
Golden Star Resources Ltd. (GSS - Free Report) , Randgold Resources Ltd. GOLD and Kinross Gold Corp. (KGC - Free Report) can be solid additions to one’s portfolio. Golden Star Resources has an expected earnings growth of 50% for fiscal 2017 and 183.33% for fiscal 2018. The stock currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Randgold Resources carries a Zacks Rank #2 (Buy) and has an expected earnings growth of 26% for fiscal 2017 and 27% for fiscal 2018. Kinross Gold, another Zacks Rank #2 stock, has an expected earnings growth of 14% for fiscal 2017 and 59% for fiscal 2018.
However, we suggest staying away from or getting rid of Zacks Rank #5 (Strong Sell) stocks such as Yamana Gold Inc. (AUY - Free Report) and Pretium Resources Inc. (PVG - Free Report) . These stocks have witnessed downward revision in their estimates.
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