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 in China
Gold jewelry demand is being negatively affected by the slowing economic environment as well as changing consumer tastes in its main consumer, China. 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 jewelry 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 jewelry. 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.
Further, it has been observed that travel, entertainment and dining now command a major chunk of consumers’ budgets rather than gold. Per China’s National Tourism Administration, over 700 million Chinese travelled during the October week-long National holiday and domestic travel revenues increased 13% year over year .
Brexit Anxiety Quells Demand in UK
In UK, demand continues to be affected by jitters over Brexit. Anxious consumers are uncertain over the likely economic impact of Britain’s exit from the EU.
Production to Dwindle
Even through a small number of major projects came 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 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 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.
Gold Substitutes in Technology
Demand for gold in technological applications has been 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.
The Federal Reserve hiked interest rate for the third time this year by 25 basis points to a range of 1.25-1.50% and projects three hikes in 2018. Higher rates normally translate into a stronger dollar which results in lower gold prices. 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 2018 earnings estimates for Asanko Gold have plunged 83% in the last 90 days.
Kirkland Lake Gold Ltd. (KL - Free Report) , another Zacks Rank #4 stock has seen a 4% drop in earnings estimates in the last 60 days.
Pretium Resources Inc.’s (PVG - Free Report) estimates for fiscal 2018 have gone down 14% over the last 90 days. The stock has a negative earnings surprise of 5.24% over the past four quarters and carries a Zacks Rank #4.
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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