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Where Will Gold Mining ETFs Go From Here?

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After a green January, gold miners posted their best monthly gains since 1998 in February. The wind beneath the wings was the safe-haven demand of the underlying metal in the wake of heightened upheaval in the global market. Also, a subdued greenback worked like a miracle for this otherwise downtrodden metal.

The largest gold mining ETF – Market Vectors Gold Miners ETF (GDX) – was up over 32% in February while a 9.8% gain was realized by the biggest gold ETF SPDR Gold Shares (GLD) after three successive years of decline. The former ETF put up with more pain as mining companies often trade as a leveraged play on gold (read: February ETF Asset Update: Safe Assets Gain; Stocks Shed).

Oil price worries, hard landing fears in China, softer global economic data, sub-par corporate guidance, and super-accommodative monetary policies in regions like Euro zone and Japan initiated the ‘Great Un-rotation’ – stocks to bonds – to start 2016.
As a result, apart from bonds, gold has also proven to be a big winner of this flight to safety. Also, chances of a delayed Fed rate hike this year and overvalued stock markets in the U.S. propelled gold prices higher.

Can the Surge Continue?

The road ahead is mixed for the gold mining companies with downside risks weighing a little heavily, in our view. We’ll tell you why.

Opportunities

Falling Supplies: As per the World Gold Council, there was a 4% decline in global gold supplies in 2015. Mine supply grew at its lowest level in seven years at 1%, while recycled gold tanked 7%, marking an eight-year low. In short, production cuts to contain the gold market rout can shore up the sector, albeit very slowly.

Steady Bar and Coin Demand: Gold demand for investment purposes is gaining ground. In China itself, demand was up 21% in 2015 while globally, demand nudged up 1%. Also, if the Fed moves slowly on the policy tightening front this year, the metal would find some support from a benign U.S. dollar.

Favorable Zacks Rank: The gold mining sector is in the top 22% in the Zacks Industry universe, at the time of writing. Many gold mining companies underwent a rank upgrade this week with the majority holding Zacks Rank #3 (Hold) or Zacks Rank #2 (Buy) (read: Gold Mining ETFs Surge Despite Mixed Earnings).

Threats

Declining Safe Haven Demand: With sell-offs looking overdone and risk-on sentiments returning to the market on a host of positive data points, the drive for super safe assets started retreating. Yields on the 10-year bench mark Treasury notes recently spiked after improvement was noted in manufacturing activity, construction spending and auto sales in the U.S. So, the safe bid is likely to provide less support to this metal, going forward.

Jewelry Demand in China Dipping: Since the world’s second largest economy is suffering from a slowdown, demand for gold from the top gold consumer will decline. In China, demand for jewelry dropped 3% in 2015.

Imposition of Gold Tax in India: Though demand rose 5% in the second largest gold consumer, India, in 2015, ominous clouds are hanging over this market. India’s budget for 2016, a sales tax on gold jewelry was reinstated after four years. This could lead to falling gold demand in India, going forward.
 
At the time of writing, GDX is trading above its long (200-day), intermediate-term (50-day) and short-term (9-day) simple moving averages which signify bullishness for the ETF. Also, the biggest fund in the space, GDX, is yet to enter the overbought territory as depicted by the Relative Strength Index (RSI) value of 61.54, indicating room for further price gains.
 
Bottom Line
 
Investors should note that though the gold mining companies and the related ETFs perhaps secured gains lately, the strength was mainly reflective of safe-haven demand. Earnings played a minor role in their ascent. We are not sure of how long this surge will last. As long as the market remains volatile, gold-based ETFs will fire on all cylinders (read: Believe in Goldman? Short Gold with These ETFs).
 
 
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