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Mining (Gold) Update & Outlook - June 2013

Zacks Equity Research

Tale of Gold: What Has, Is and Will Happen

Gold may have lost the battle to diamonds in becoming a girl’s best friend, but the yellow precious metal can very well qualify as historically the most desirable metal. The attributes including malleability, resistance to corrosion and tarnishing, and the glitter makes it ideal for many jewelry purposes. But there is more to Gold; and that is the opportunity that the metal provides for investors.

Gold investors buy gold bullion, official coins as a hedge against inflation or a safeguard against the collapse of paper assets such as stocks, bonds and other financial instruments. Gold ETFs (Exchange-Traded Funds) have also become very popular as an investment option.

Gold ETFs are units representing physical gold, which may be in paper or dematerialized form and are traded on the exchange like a single stock of any company. Governments, central banks and other official institutions hold significant quantities of gold as a component of exchange reserves.

Gold Mining Industry – A Brief Overview

Gold exploration and mining is a time consuming and expensive endeavor. 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 and hazards 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 the mine development project is successful, returns can be enormously high, which more than offsets the risks and the capital invested.

Industry Ranking & Outlook

Within the Zacks Industry classification, the gold industry falls under the broader Basic Materials sector (one of 16 Zacks sectors). We rank all of the more than 260 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available in the Zacks Industry Rank page.

The way to align the ranking and outlook from complete list of Zacks Industry Rank for the 260+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #87 and lower) is positive, while the outlook for the bottom one-third (Zacks Industry Rank #174 and higher) is negative. Currently, the gold mining industry is featuring in the bottom 1/3rd with a Zacks Industry Rank of #251, indicating the outlook is on the ‘Negative’ side.

Please note that the Zacks Rank for stocks, which is at the core of our Industry Outlook, has an impressive track record going back years, verified by outside auditors, to foretell stock prices, particularly over the short term (1 to 3 months). The rank along with Expected Surprise Prediction (ESP) (Read: Zacks Earnings ESP: A Better Method) helps in predicting the probability of earnings surprises.

There is a lot of buzz in recent days surrounding gold prices. Let's look at the driving factors, recent trends and the road ahead:

What affects gold prices?

Gold prices fluctuate on a daily basis and are influenced by industrial and jewelry demand, demand for gold as an investment, central bank lending, sales and purchase of gold, volume of recycled material available in the market, speculative trading; and costs and levels of global gold production by producers of gold.

There are a number of economic factors as well that influence gold prices. Over the past few years, the price of gold has shown a high inverse correlation with the U.S. dollar. In the wake of dollar weakness, investors opt for gold as a safe haven. Other factors include expectations of the future rate of inflation, interest rates; and global or regional, political or economic uncertainties.

Recent Price Trends: Alarming Drop Witnessed in April and May

In 2012, gold’s average market price of $1,669 per ounce was an all-time record high, representing a 6% annual increase. Lingering concerns about Europe’s financial problems, China’s reduced economic growth, announcement of the third round of quantitative easing (QE3) led to a surge in gold prices.

In the first quarter of 2013, gold prices ranged from $1,574 per ounce to $1693.75 per ounce, with average gold price at $1,631.8 per ounce, down 3% year over year. However, gold prices slumped drastically subsequent to the first quarter.

On Apr 12, prices dipped 9% in 1 day from $1,535.50 to $1,395 per ounce, a level last witnessed in Feb 2011. After a short-term correction, the price dipped to the lowest level in 2013 of $1,354.75 on May 20.

Year to date, gold prices have fallen 18%. This steep drop has technically put the yellow metal in a bear phase, leading to widespread concerns and questions such as -- why gold is going down, whether it will last, and whether it can still be termed as a ‘safe haven.’

Why is the sheen wearing off?

It was not a day’s event that affected the gold market, but the unfavorable factors had been building up over the past few months. The U.S economy started showing signs of a revival. As mentioned earlier, the strengthening of the US dollar has an inverse relationship with gold prices. Monetary easing in Japan led to dollar’s strength, thus proving the theory.

A decline in inflation level across the globe also reduced gold’s value as a hedge against rising prices. Furthermore, anticipation that U.S Fed’s QE3 could end soon also influenced the fall.  Rising interest rates make bonds more attractive than gold. The final straw was the news that Cyprus may sell gold from its reserves. This led investors to offload their positions in gold.

What Lies Ahead

Analysts continue to see rough days ahead for gold. They have cut down their estimates for 2013 as well as 2014, citing mounting headwinds from a strengthening dollar, improving U.S. growth, rising interest rates, subdued inflation and lack of investment buying. However, they expect prices to remain above 1,500 per ounce in 2013.

The recent plummet in prices has dealt a severe blow to investor confidence for the yellow metal. This may take many months to restore. Even though it has resulted in major losses in the paper gold market, it has otherwise triggered a gold rush for the actual physical metal, in the form of bullion, jewelry, bars and coins. Thus, gold prices will at least become stable if not move higher as retail demand for gold lends support, particularly in India and China.

Demand Dynamics

Total gold demand stood at 963 tons in first quarter 2013, down 13% as substantial net outflow from gold ETFs offset growth in consumer demand for gold and from central banks. Technology demand was down due to weak consumer demand, uncertainty in Europe and substitution to more affordable alternatives.

Jewelry demand soared to 551 tons in the quarter, helped by lower price levels. Even though India and China (62% of the global jewelry demand) were at the forefront with respective annual growth of 15% and 19%, respectively, other markets also improved, particularly the U.S.

In India, a good spring harvest and lower prices ahead of the wedding season triggered the increase. In China, festive buying for the Chinese New Year and regained confidence in China’s economy led to a record quarter.

The surprise package in the quarter was U.S with jewelry demand increasing after a hiatus of seven years, fueled by positive signs of U.S recovery and lower prices. Demand had been low due to weak consumer sentiment against a backdrop of high unemployment, falling real wages and rising gold prices. Demand for gold bars and coins stood at 378 tons, well above the five-year quarterly average, fueled by demand from India, China and the US.

Central banks remained the primary purchasers of gold, accounting for around 11% of total gold demand at 109.2 tons. Demand topped the 100 ton mark for the seventh consecutive quarter, a testament to the fact that central banks continue to favor gold’s diversification benefit as they reduce their portfolio allocations to US dollars and euros.

On the contrary, the quarter witnessed a 176.9 tons net outflow from gold ETFs. This led to overall investment demand decline of 49%. This performance brings to light the conflict in behavior of investors at the retail level and the investment level.

Retail investors (in gold bars and coins) view gold for preserving wealth and hedging against inflation over the long term. Thus, in the first quarter, demand from retail investors remained high as they saw an opportunity to add to their holdings as gold prices dipped.

On the other hand, the institutional investors have a different perception with a short term, speculative approach. The price drop in the quarter prompted these opportunistic investors to sell their ETF holdings and shift to other investment options.

Gold-backed ETFs have seen outflows of 350 tons out of a total of 2,700 tons held in 2013 till April end. Further price pressure could lead to continued outflow in the near term. On the contrary, bar and coin demand has leaped to unprecedented levels.

This phenomenon is not constrained to Asian markets only. In the US, total number of American Eagle coins sold in April recorded the highest ever dollar value of $311 million. The UK mint reported a tripling of coin sales in April, and the Perth mint in Australia reported the highest demand levels in five years.

With buyers flocking the gold retail stores, several key markets have reportedly run out of stock, particularly in China and India. In April and May, India imported around 300 tons, nearly twice the average level.

However, to rein in the surging demand, India has increased the duty on gold imports. Nonetheless, this increase in the import duty is unlikely to impact imports, as consumer demand remains at very high levels.

The World Gold council expects 300-400 tons of gold to be imported into India during the second quarter, a 200% annual climb. China, another major consumer, is not far behind as imports from Hong Kong are also reported at high levels.

The official sector is expected to continue to be the net buyer of gold. Gold will also enjoy demand from industrial and technology companies for a wide range of products.


A combination of current mine production, recycling and draw-down of existing gold stocks held by governments, financial institutions, industrial organizations and private individuals, constitute the annual gold supply.

In the first quarter, mine production was at 688 tons, up 4% year over year and 2% above the five-year quarterly average of 671.9 tons. Production increased in the Dominican Republic fueled by Barrick Gold Corporation’s (ABX) Pueblo Viejo mine and in China. Growth was also noted across several mines in Canada and Brazil. Goldcorp Inc.’s (GG) Penasquito mine continued to ramp up production in Mexico.

Recycling of gold contributed 366.6 tons to total supply in the first quarter, 4% lower year over year, the fourth consecutive quarter of annual decline. This was due to reduction in the available supply of gold and economic factors. Overall, gold supply increased a meager 1% to 1,051.6 tons.

Performance of Gold Companies

As we delve into the March-end quarterly numbers of the gold companies in our coverage – Barrick Gold Corporation, Harmony Gold Mining Company Limited (HMY), Newmont Mining Corporation (NEM), Kinross Gold Corporation (KGC), Agnico Eagle Mines Limited (AEM) and Goldcorp, we see earnings being hampered across the board by decline in average realized gold prices.

Shares of Newmont, Barrick Gold, Kinross, Goldcorp, Agnico Eagle and Harmony Gold hit their 52-week lows in the April-May timeframe driven by the sudden drop in gold prices, first quarter results and trimmed guidance. Furthermore, the companies are also riddled with their individual operational issues. Barrick’s stock has fallen under pressure since the April 10th announcement that the company is suspending construction at its Pascua-Lama mine in Chile, in response to a court order from a Chilean court citing environmental concerns.

The price decline added to the woes of the industry that is already grappling with rising costs, labor issues, strikes, delays and/or the cancellation of projects. This has put gold miners on the defensive, forcing them to reassessing and cutting costs. Companies like Barrick and Agnico-Eagle have trimmed down their cash cost guidance for 2013 in order to remain profitable.

If prices fall further, margins will be constrained as the price of gold closes in on the cost per ounce of the companies. Analyzing the all-in sustaining costs (total costs associated with producing gold), 2013 guidance of Barrick Gold, Newmont, Kinross, Goldcorp and Agnico Eagle ranges from $950 to a maximum of $1200 per ounce.

Even if prices continue at April/May levels, there is still a chance for these companies to earn profits. On the other hand, IAMGOLD Corp. (IAG) is running at a risk with consolidated total all-in sustaining cost guidance of $1,200 - $1,300, which is quite close to the current price.

Barrick, Harmony, Goldcorp, Newmont have decided to curtail their capital spending for the year. According to reports, Barrick Gold is contemplating to sell three of its Australian mines and its oil and gas unit -- Barrick Energy and Kabanga, its 50% owned nickel project in Tanzania to offload underperforming assets.

The key to stay afloat in these turbulent times is to identify and reduce discretionary expenses wherever possible, trim capital spending, defer new capital development programs, divest underperforming assets and cut dividends. The companies should judiciously proceed on only low-risk, high-return brownfield and the best Greenfield projects.

In the falling gold price environment, companies with major projects may require additional debt to complete them. Miners with lower costs, lower levels of debt, and with recently completed new mine development will be able to sustain themselves.


Companies have slowed down their deal activities since last year, but Chinese gold miners remained active on the acquisition front. To capitalize on the strong domestic demand for gold, Chinese companies are acquiring overseas gold mines. In 2012, China’s second largest producer, Zijin Mining Group, bought Australia-based Norton Gold Fields and the third largest gold producer, Shandong Gold Group, acquired majority stake in Australia’s Focus Minerals.

Australia was a preferred target considering it is the world's second-largest gold producer, after China. Hong Kong-listed Kingwell Group Limited recently made an offer to Canada-based Brazilian Gold Corporation to acquire not less than 50.95% of its share. Brazilian Gold focuses on the acquisition, exploration and development of gold properties located in northern Brazil.

To Sum Up

Demand for gold will undoubtedly continue to rise, thanks to the rising middle class in India, China, Latin America and other emerging markets. The Euro-zone debt crisis will also be an important driver for gold demand. Furthermore, demand for gold bullion and coins is currently at an unprecedented level. It may however take months for this new demand to feed into prices, but prices will eventually stabilize.

According to the World Gold Council, the bull market for the yellow metal is very much intact even if there’s a lot of uncertainty at the moment for investors. Gold is expected to return to pre-April levels as the long-term drivers of demand are firmly in place.  

The consumers who rushed to buy gold following the fall in prices might have to wait patiently for their anticipated returns to materialize. At current levels, one should invest in gold as a long-term investment, which will grow in value and add diversification to a portfolio. For quick returns, it is advisable to focus on other assets.

BARRICK GOLD CP (ABX): Free Stock Analysis Report

AGNICO EAGLE (AEM): Free Stock Analysis Report

GOLDCORP INC (GG): Free Stock Analysis Report

NEWMONT MINING (NEM): Free Stock Analysis Report

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