Gold Industry Stock Outlook - Feb. 2015

Will India Breathe Life into the Gold Mining Industry?

Looking back at 2014, the main highlights of the gold industry were: strong demand in India and U.S. but weak global demand, record mine production and stable gold prices with relatively low volatility. Average price in 2014 stood at $1,266.4 per ounce, a 10% drop from the average price of $1,411 per ounce in 2013.

Gold started off 2015 with a bang as safe haven buying mainly due to increase in currency volatility, uncertainly over Greece’s future in the euro zone and expected quantitative easing in Europe, propped up prices. However, the gains fizzled out as gold prices again dropped on strong U.S jobs report for the month. Following which, gold prices fell to new six-week lows as equities recovered on hopes that Greece would work out a deal with its creditors. Moreover, China, the world's second largest gold consumer, will be closed for a week during the Lunar New Year holiday, thereby removing a key support for gold prices.

Share prices of some of the gold miners, like Goldcorp Inc. (GG - Analyst Report), Barrick Gold Corp. (ABX - Analyst Report), Yamana Gold, Inc. (AUY - Snapshot Report), Kinross Gold Corp. (KGC - Analyst Report), Agnico Eagle Mines Ltd. (AEM - Analyst Report) and Newmont Mining Corp. (NEM - Analyst Report), have taken a beating following the dip in prices.

Let's take a deeper look at the drivers of price — the classic case of supply and demand.

Global Demand Lags Y/Y; U.S., India Show Resilience

As per the World Gold Council, total gold demand dipped 4% in 2014 to 3,924 tons. This was not surprising as the year was pitted against remarkable demand levels witnessed in 2013, when customers flocked to buy gold due to the 25% drop in prices.

In 2014, global jewelry demand dropped 10% to 2,153 tons. After a weak first half, demand for jewelry surged in the fourth quarter, marking the strongest quarter witnessed since 2007, mainly due to India and U.S. Jewelry demand was a record 662 tons in India for the year, thanks to the festive buying during Diwali and the wedding season.

In the U.S., full-year demand was at 132 tons -- the highest in five years. On the contrary, China could not match last year’s surge, and was down 33% at 624 tons. Seasonal buying in the fourth quarter, ahead of the Chinese New Year, has been pushed to January this year due to the altered timing of the lunar calendar.

In the technology sector, gold demand was down 5% to 389 tons, the lowest level since 2003. Sluggish economic conditions in key markets and substitution with cheaper materials led to the drop.

Overall investment demand increased 2% to 905 tons in 2014, mainly due to a slowdown in outflows to 159 tons from 880 tons in 2013. This was driven by a stronger greenback, improvement in the U.S economy and the relatively stable gold price environment. Total bar and coin demand plunged 40% to 1,063 tons from the phenomenal levels of buying in 2013. Previous year’s accumulation created a general reluctance in further buying.

Central banks remained the primary acquirers of gold, purchasing net 477 tons over the year, a 17% increase year over year. Last year marked the second-highest year of central bank net purchases in the past 50 years. Russia accumulated the most, accounting for 36% of total central bank demand at 173 tons driven by tension and uncertainty for the country. Kazakhstan, Iraq and Azerbaijan also made sizeable purchases. Fortification and diversification of reserves, namely away from the US dollar, was the driving force behind this.

Supply Remained Flat Despite Record Mine Production

Mine production in 2014 was at record 3,114 tons, up 2% year over year. China, Mongolia and Argentina stayed at the top of the leader board. Goldcorp’s Cerro Negro mine poured its first gold in 2014. The high-grade operation boasts reserves of 5.7 million ounces. In Africa, the $2.5 billion joint venture between Randgold Resources Ltd. (GOLD - Snapshot Report), AngloGold Ashanti Ltd. (AU - Snapshot Report) and state miner Sokimo poured its first gold in September from the Kibali mine.

When in full production, Kibali will rank as one of the largest gold mines in Africa with an expected average production of 600,000 ounces of gold per annum over the first twelve years of its life. Endeavour Mining Corporation’s (EDVMF) Agbaou mine at Cote d’Ivoire came on stream at the beginning of 2014.

Recycling of gold dipped 11% year over year to 1122 tons, a seven-year low. Consumers refrained from selling their holdings due to the steady gold price environment. Hence, overall gold supply remained flat year over year at 4,278 tons in 2014 as record annual mine production was neutralized by shrinking volumes of recycling.

Sector Level Earnings Trend

Currently, 76.2% of the stocks in the basic material sector have reported their fourth-quarter results. The companies have put earnings growth of 3.9% on the scoreboard. Taking into account the other companies that are yet to report their results, earnings of the Basic Material sector is expected to edge up 2.6% in the fourth quarter, drastically down from the 17.6% increase in the third quarter of 2014.

Going forward, the sector is projected to decline 5.1% in the first quarter of 2015 and recover with a growth of 4.2% in the second. However, earnings are again projected to decline 3.7% in third-quarter 2015 and increase 6.4% in the fourth quarter.

Despite the choppiness, the sector will log earnings growth of 2.8% in 2015 and accelerate to growth of 20.6% in 2016. (For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)

Industry Ranking & Outlook – Positive
 
Within the Zacks Industry classification, the gold industry falls under the broader Basic Materials sector (one of the 16 Zacks sectors). We rank all of the more than 258 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. http://www.zacks.com/stocks/industry-rank

The way to align the ranking and outlook from the 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 #86 and lower) is positive, the middle one-third (Zacks Industry Rank between #87 and #172) is 'Neutral' while the outlook for the bottom one-third (Zacks Industry Rank #173 and higher) is negative. Currently, the gold mining industry is featured in the top tier with a Zacks Industry Rank of #57, indicating a positive outlook.

What’s in Store for 2015?

Impending interest rate increases in the second half of 2015 and a stronger U.S. dollar will keep gold prices under pressure throughout the year. Cheaper oil means lower inflation, which suggests gold should be negatively affected since it is considered a hedge against inflation. Better economic prospects and lower inflation are positive for equities and negative for assets like gold that don’t offer any income.

However, gold prices will get support from retail demand for gold, particularly in India and China. India is currently the world’s top gold consumer. Lower prices, easing of import norms, a new government and better prospects for economic growth exhibit an encouraging backdrop for gold demand in India. Central bank demand will also support prices as demand from this sector has been remarkably consistent.

Going forward, we believe that growth in supply from mining projects will slow as the supply pipeline thins. Lower gold prices than in previous years and cost pressures have restricted the ability of gold producers to invest in developing new projects in recent years.

Given the dearth of new projects, mine production will slow down in the next couple of years. This could eventually lead to a supply crunch that would support prices. A positive Zacks Rank and projected earnings growth for 2015 makes a good case for the gold mining industry.