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Gold Mining Stock Outlook - January 2018

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Gold prices scaled a three-month high on the last trading day of 2017, its best yearly performance since 2010. Notably, spot gold has surged more than 12% last year -- its strongest gain since 2010. The performance is particularly noteworthy in a year when the Fed has been hiking rates and equity markets remained strong.

The bullish momentum has continued in 2018 so far, with gold currently trending above the psychological level of $1,300 an ounce. The rally can be attributed to weaker dollar and renewed safe-haven buying prompted by heightened geopolitical tensions.

Weaker Dollar Aiding Gold’s Cause

Gold is sensitive to dollar fluctuations. The dollar slumped almost 10% in 2017, marking its worst performance since 2003, even though the dollar had started that year on a high, riding hopes that President Trump would implement pro-growth and pro-inflation measures.

However, concerns about Trump's ability to push through those policies started to weigh on the greenback soon. Further, it lost steam as growth picked up outside the United States, with other countries' central banks moving toward tighter monetary policy, consequently narrowing the gap between the Federal Reserve and others. Moreover, tensions regarding North Korea and persistently low U.S. inflation led to the decline.

Demand Dips in First Nine Months of 2017

Per the data available from the World Gold Council, global gold demand declined 9% year over year to 915 tons in the third quarter of 2017 -- at par with levels last seen in the third quarter of 2009. In the first three quarters of 2017, demand for the yellow metal was down 12%. Let’s have a detailed look at what led to the decline.

Jewelry Demand: Strength in China & United States, India Disappoints

After recording growth in the first half of 2017, demand for jewelry dipped 3% year over year to 479 tons in the third quarter -- the weakest third quarter on record. Nonetheless, China witnessed a boost of 13% on festive buying after 10 consecutive quarters of decline. Moreover, the United States marked the strongest third quarter in the last five years, driven by economic growth, improving employment levels and growth in consumer confidence.

Notably, India witnessed the main drag on jewelry demand in the quarter, declining 25% after three straight quarters of growth. The introduction of the 3% Goods and Services Tax (GST) at the beginning of July affected sales. In anticipation of the tax, customers had also moved their purchases to the second quarter.

Additionally, to make matters worse for the industry, the government brought the gems and jewelry industry under the purview of the Prevention of Money Laundering Act (“PMLA”) in August. The Act required declaration of documentation for certain jewelry transactions. This deterred customers in rural India as they shied away from providing necessary documents. Further, inconsistent rainfall had its toll on gold jewelry buying in rural India, which is a major market.

In October, the India jewelry industry heaved a sigh of relief as the government removed the industry from the purview of the PMLA — a well-timed step, ahead of the festive season. As a result, consumer sentiment improved dramatically.

Total Investment Demand Suffers on Modest ETF Inflows

Total investment demand plunged 28% to 334.5 tons in the third quarter. ETF inflows were 18.9 tons, down from the record inflow levels of 144.3 tons in the prior-year quarter. In fact, the U.S.-North Korea imbroglio, along with its constant threat of nuclear conflict, had stoked the demand for gold investment for the first time.

However, as it became clear in September that the Fed is likely to raise rates in December, investment in ETFs was affected. Also, stock markets at new highs led to the modest ETF inflows.

Meanwhile, global bar and coin demand improved 17% year over year to 222.3 tons on the back of robust demand in China. Currently, the country is witnessing the second highest volume on record in 2017. The volume is being aided by fears related to potential depreciation of the yuan, concerns over rising inflation and lack of alternative investment opportunities.

Demand from Central Bank, Technology Show Resilience

Central banks purchased 111 tons in the third quarter, up 25% year over year. This brought the total to 289.6 tons year to date, down 3% year over year. Russia, Turkey and Kazakhstan remained primary buyers. Demand for gold in technology improved 2% year over year to 84.2 tons in the third quarter, marking the fourth consecutive quarter of growth.

Supply Growth Continues in the Red: Signal of Caution?

Total gold supply contracted by 2% to 1,146 tons in the third quarter. Recycled gold supply declined 6% year over year to 315.4 tons and mine production was down around 1% year over year to 841 tons. However, on a positive note, production in the first nine month period of 2017 was at a record high of 2,420 tons.

Production in China continued to decrease for five consecutive quarters due to stringent environmental regulations. In Tanzania, an ongoing dispute between the government and Acacia Mining led to a 15% fall in production.

Sector Level Earnings Trend

Per the Zacks classification, the gold-mining industry comes under the broader Basic Materials sector. The sector’s earnings rose 2.7% in the third quarter, a deceleration from growth of 7% witnessed in second-quarter 2017 and 13.5% in the first.

However, the sector is likely to bounce back in the fourth quarter with an impressive 26.9% projection for earnings growth. Thereafter in 2018, the sector is expected to log growth of 18.9%, 14.8%, 8.7% and 5.6% in the first, second, third and fourth quarters of 2018 respectively. (For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)

Industry Ranking - Positive

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 top half of the Zacks classified industries with a Rank of #104.

Attractive Valuation, Upside Remains

The Gold Mining industry has advanced 5% compared with the S&P 500’s growth of 22.8% in the past year. 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 multiple of 7.65, much lower than the S&P 500’s EV/EBITDA multiple of 12.33. The industry’s lower-than-market positioning calls for some more upside in the quarters ahead.

Where Is the Industry Headed?

Per the World Gold Council CEO, Aram Shishmanian, there are plenty of reasons to be optimistic about gold’s performance in 2018. He noted “U.S. interest rates may be rising but a lot is priced into the curve already and the direction of the dollar remains uncertain. Meanwhile, the long bull market in equities raises serious questions about prospects for stock prices.”

A number of new mines entered production in fourth-quarter 2017, which might support mine production till 2018. Noteworthy mines include The Natalka project in Russia, Canada’s Rainy River project and Houndé in Burkino Faso. However, in China, the largest producer since 2007, production will bear the impact of recently imposed regulations, which target the discharge of cyanide in tailings for few quarters.

On the demand side, major markets, India and its neighbor China will continue to be growth drivers. Last year, the Indian market had suffered a setback due to the impact of imposition of Good and Service Tax (“GST”) and anti-money laundering legislation (“AML”) around jewelry retail transactions. We expect it to bounce back as the market adapts to GST.

Pent-up demand as well as festive buying is anticipated to boost demand for jewelry in the country. Moreover, government measures like mandatory hallmarking in 2018, is likely to be a positive for the industry. In China, retail demand remains high around the Chinese New Year.

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 in nature, due to festival and wedding related buying activities in countries like India and China.

Further, the United States continues to be a strong market driven by economic growth, improving employment levels and growth in consumer confidence. Elsewhere, Germany’s economy is expected to maintain momentum while unemployment is anticipated to continue declining, providing support for the world’s third-largest bar and coin market.

Demands from central banks also remain strong with Turkish and Russian central banks adding to their gold reserves. Further, gold is witnessing increased demand in technology, bolstered by demand for high-end smartphones after years of declines.

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 stoked the prices 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.

While demand will remain strong, supply of this precious metal has already attained peak levels as per reports. Per the World Gold Council, the project pipeline will experience a small pick-up in 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

Solid ranking, low valuation and earnings growth expectation makes a good investment case for the gold mining industry now. Investors can consider the following gold stocks that are backed by a solid Zacks Rank.

Barrick Gold Corp. , Franco-Nevada Corp. (FNV - Free Report) and Sandstorm Gold (SAND - Free Report) carry a Zacks Rank #2 (Buy) and can be solid additions to your portfolio. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Barrick Gold has an expected earnings growth of 16.89% for 2018 and 11.01% for fiscal 2019. Franco-Nevada Corp. has an expected earnings growth of 6.81% for fiscal 2018 and 14.40% for fiscal 2019. Sandstorm Gold has an expected earnings growth of 90.91% for fiscal 2018 and 100% for fiscal 2019.

However, we suggest staying away from or getting rid of Zacks Rank #4 (Sell) stocks such as Asanko Gold Inc. , Kirkland Lake Gold Ltd. and Pershing Gold Corp. .

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