Though the market 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 have discussed some of the key challenges and what investors in the sector should be wary of in the coming months and years.
Changing Preferences of Younger Generation in China
For the second quarter, China’s economy grew by 1.7% in seasonally adjusted terms. It was in line with expectations but higher than 1.3% increase reported in the March quarter.
The International Monetary Fund’s (IMF) forecast for growth in China is pegged at 6.7% for 2017. As per the IMF, a faster slowdown in China could have a serious impact on trade, commodity prices and investor confidence, and lead to a more generalized slowdown in the global economy. Even though the recent upbeat GDP figures raise hope, it remains to be seen whether it can be sustained.
While rebalancing progresses, the Chinese economy continues to slow down. 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. 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.
Recently, a shift from pure 24k gold to lower-carat, higher-designed and higher-margin gold jewellery has been witnessed among the young customers in China. Consumers are expressing their individuality and differentiating themselves from older generations — leading to the shift from traditional plain 24k jewellery. As younger consumers continue to shy away from the tradition jewelry, higher-margin, lower-gold-content products are being developed to fill the void. Retailers and manufacturers are attempting to prosper in a competitive industry by alluring customers with new, innovative and higher-margin products.
Brexit Anxiety Quells Demand in UK
In UK, demand in the second quarter of 2017 slumped 10% to a three-year low of 3.8 tons due to prolonged uncertainty over Brexit, which continues to deter anxious consumers.
Production at Risk
Even through a small number of major projects are anticipated to come online by the end of 2017, the project pipeline remains weak. And while major miners have improved cash flow and reduced debt over the last few years, production development expenditure remains at multi-year lows. 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.
Previously, incremental production from newer mines led to continued growth in overall gold production. However, newer mines are now at or near full potential, leading to slowing down in growth rates. This has made further production gains increasingly difficult.
This is the aftermath of sharp cuts in capital expenditure 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 completely and ultimately leading to a supply crunch.
Some gold companies, including Barrick Gold Corp. (ABX - Free Report) , Goldcorp, Inc. (GG - Free Report) 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 Substitutes in Technology
Demand for gold in technological applications is affected by cheaper substitutes. 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 US 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. Also, higher U.S. rates raise the opportunity cost of holding non-yielding bullion and normally weigh on gold.
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.
Asanko Gold Inc. (AKG - Free Report) currently carries a Zacks Rank #4 (Sell). The 2017 earnings estimates for Asanko Gold have gone down by 59% in the last 30 days and for 2018 have plunged 58%.
Yamana Gold Inc. (AUY - Free Report) , carries a Zacks Rank #5 (Strong Sell) and has witnessed a 43% drop in estimates for fiscal 2017 and 24% for fiscal 2018. The company posted a negative average earnings surprise of 94.17% in the trailing four quarters.
Pretium Resources Inc. (PVG - Free Report) , another Zacks Rank #5 stock, has witnessed a 55% drop in estimates for fiscal 2017.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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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