Looking back at the first half of this year, the major highlights for the gold mining industry were- “Record H1 investment demand” and a “25% rise in gold price.” Record gold ETF inflows drove investment demand 16% higher than the peak attained during the recession.
After three lackluster years, gold prices finally seem to have found solid ground, surging 25% in the first half and remaining above $1,300 an ounce threshold, making it the best H1 since 1980. The yellow metal has been the best-performing asset, trumping major equity indices, investment grade and high yield bonds as well as commodity indices.
What Led to the Surge?
Worries over the global economy, Brexit-induced volatile equity markets, the Federal Reserve’s (Fed) stance to maintain steady interest rates and the introduction of negative interest rates by several central banks increased the safe-haven appeal of gold.
With the uptrend in gold prices, gold producers staged a comeback this year after suffering harrowing losses last year. The emphasis on cost management as a reaction to lower gold prices in recent years has borne fruit. In the second quarter, year-on-year total cash costs and all-in sustaining costs fell 6% and 8%, respectively.
While further cost cuts appear difficult, costs are now under control and producer margins are now at healthy levels. Top gold producers Barrick Gold Corporation (ABX - Analyst Report) , Newmont Mining Corporation (NEM - Analyst Report) , Agnico Eagle Mines Limited (AEM - Analyst Report) all reported a rise in second-quarter earnings buoyed by higher gold prices.
Solid Investment Demand Leads to Record Demand in H1
As per the World Gold Council, the first half of 2016 was the best on record with total gold demand rising 18% year over year to 233.5.5 tons. Investment demand was at 1,063.9 tons, a 127% rise year over year. Additionally, it was 16% higher than the previous H1 high since 2009, when the market was in the doldrums due to recession.
Further, for the first time on record, investment demand has been the largest component of gold demand for two consecutive quarters fueled by pent-up demand among Western investors across the board, from retail to institutional and for bars, coins and ETFs. In fact, the growth in demand for gold-backed ETFs has outperformed all other sectors in the first half with demand at 580 tons, bettering the previous high of 458 tons in the first half of 2009.
Negative Interest Rate Policies (NIRP) implemented by central banks in Japan and Europe, Fed’s dovish stance on interest rates, uncertainty regarding Brexit, upcoming US elections, the increasingly parlous state of Italy’s banking sector and geopolitical unrest in the Middle East triggered a flight to safety.
On the contrary, jewelry demand plunged 17% to 925.3 tons in the first half of 2016 as high gold prices affected consumer sentiment. Demand in the second quarter was at 444.1 tons, the lowest quarterly total in six years mainly due to combined weakness in India and China. In India, following the nationwide strike that ended in April, pent up demand did not work in favor of gold due to the reigning high prices which deterred customers from buying.
Further, two consecutive years of deficient monsoon rainfalls took its toll on rural spending that accounts for almost half of India’s demand. Government regulations and additional 1% excise duty on jewelry manufacturing also had a negative impact. Demand in China at 322.5 tons in H1 was the lowest first half total in four years due to highs prices against a backdrop of continued economic slowdown. In the technology sector, gold demand was down 3% to 161 tons in the first half of the year.
The central banks were the primary acquirers of gold, purchasing 185 tons net over the half. At June-end, world official gold holdings were over 32,800 tons, the highest value since the first quarter of 2013.
Supply Up in H1: Will It Be Sustained?
Total supply in the first half surged 8% year on year to 2,307 tons. Increase in total mine supply (net of mine production and net hedging) was 8%. Mines like Fresnillo PLC’s Herradura and Noche Buena in Mexico and Torex Gold Resources Inc.’s TORXF El Limon-Guajes mine in Mexico, Goldcorp Inc.’s (GG - Analyst Report) Éléonore and Cochenour mines in Canada, Guyana Goldfields Inc.’s GUYFF Aurora project and Troy Resources Limited TRYRF Karouni project in Guyana continued to add to the numbers. Another marked improvement was the 10% increase in recycling activity triggered by the dramatic price increase.
However, the increase in production is a temporary phase as project pipeline is seen to be diminishing. In recent years, additional production from new mines brought on stream has waned. Producers have cut down on expenditure and are focused on maximising production from their existing portfolio of assets.
Sector Level Earnings Trend
As per the Zacks classification, the gold-mining industry comes under the broader Basic Materials sector. Though the sector is projected to dip 1%, it is not that steep compared to the 11.6% decline witnessed in the second quarter. A dramatic recovery is projected during the fourth quarter with an 18.2% growth. The sector will log growth of 4.8% and 8.5% in the first and second quarters of 2017 respectively. (For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)
Industry Ranking & Outlook – Neutral
We rank all of the more than 255 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available on the Zacks Industry Rank page. The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 255+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #85 and lower) is positive, the middle one-third (between #86 and #170) is neutral while the outlook for the bottom one-third (Rank #171 and higher) is negative.
Currently, the gold mining industry is in the middle tier with a Zacks Industry Rank of #165, indicating a neutral outlook.
Recent improving economic data has increased the speculation regarding a Fed rate hike this year. In case of a rate hike, the dollar will further appreciate, making dollar-denominated commodities like gold less appealing. Nevertheless, as we are at the later end of the year, gold prices are seasonally stronger aided by retail demand for the metal, due to festival and wedding related buying activities in countries like India and China. Demand from the central bank will also support prices as this sector has remained remarkably consistent.
While demand will remain strong, supply of this precious metal has already attained peak levels as per reports. Following a seven-year stint of rising output, production of gold is likely to decline by 3% in 2016. Lower gold prices in the past few years had restricted the ability of gold producers to invest in new projects. Lower mined gold supply could help prices navigate north.
Grab These Gold Stocks to Shine Your Portfolio
A positive outlook for the industry reinforced by expectations of earnings growth eventually in 2016 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 and estimate revisions.
With positive estimate revisions over the past two month, positive record of earnings surprises in the recent quarters, and robust earnings growth projected for this year and next, Newmont Mining Corporation, can be a solid addition to one’s portfolio. The stock currently sports a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Gold Fields Ltd. (GFI - Snapshot Report) carries a Zacks Rank #2 and its estimates for 2016 have moved up around 14% over the last 30 days. The stock has an expected earnings growth of a whopping 600% for the current year.
Caledonia Mining Corporation Plc (CALVF - Snapshot Report) carries a Zacks Rank #2 and has witnessed upward movement in its earnings estimates over the past 60 days. The Zacks Consensus Estimate for 2016 is at 27 cents, a 238% improvement from the prior year.
New Gold, Inc. (NGD - Snapshot Report) also flaunts a Zacks Rank #2 and has expected earnings growth of around 491.7% for the current year. The Zacks Consensus Estimate for 2016 has moved up 60% over the last 30 days.
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