Gold Demand Declines To 8-Year Low In Q3, What's In Store?

Global gold demand declined 9% year over year to 915 tons — at levels last seen in the third quarter of 2009. Significantly lower ETF inflows compared to the prior-year quarter and weak demand for jewelry pinned down by tax, along with regulatory changes in India led to the downfall this quarter. So far this year, demand for the yellow metal was down 12%.

Total Investment Demand Suffers on Modest ETF Inflows

Total investment demand plunged 28% to 334.5 tons in the quarter. ETF inflows were 18.9 tons, down from the record inflow levels of 144.3 tons in the prior-year quarter. In fact, the U.S-North Korea imbroglio coupled with its constant threat of nuclear conflict had kindled the demand for gold investment for the first time.

However, as it became clear in September that the Fed is likely to raise rates in December, it affected investment in ETFs. Also, stock markets at new highs led to the modest ETF inflows.

Meanwhile, global bar and coin demand improved 17% year over year to 222.3 tons on the back of robust demand in China. Currently, the country is witnessing the second highest volume on record in 2017. The volume is being aided by fears related to potential depreciation of the yuan, concerns over rising inflation, lack of alternative investment opportunities that is acting as tailwinds for coin and bar investment.

Jewelry Demand — Strength in China & United States, India Disappoints

After recording growth in the first half of 2017, demand for jewelry fell 3% year over year to 479 tons in the quarter — the weakest third quarter on record. Nonetheless, China witnessed a 13% boost on festive buying after 10 consecutive quarters of decline. Also, the United States marked the strongest third quarter in the last five years driven by economic growth, improving employment levels and growth in consumer confidence. Year to date, demand for jewelry has been up 4% to a seven-year high of 76.8 tons, thus making the United States the third largest jewelry market.

Notably, India witnessed the main drag on the jewelry demand in the quarter, declining 25% after three straight quarters of growth. The introduction of the 3% Goods and Services Tax (GST) at the beginning of July affected sales. In anticipation of the tax, customers had also preponed their purchases to the second quarter.

Additionally, to make matters worse for the industry, the government brought the gems and jewelry industry under the purview of the Prevention of Money Laundering Act (“PMLA”) in August. The Act required declaration of documentation for certain jewelry transactions. This deterred customers in rural India as they shied away from providing necessary documents. Further, inconsistent rainfall had its toll on gold jewelry buying in rural India, which is a major market.

In October, the India jewelry industry heaved a sigh of relief as the government removed the industry from the purview of the PMLA — a well-timed step, ahead of the festive season. As a result, consumer sentiment improved dramatically.

Demand from Central Bank, Technology Show Resilience

Central banks purchased 111 tons in the third quarter, up 25% year over year. This brought the total to 289.6 tons year to date, down 3% year over year. Russia, Turkey and Kazakhstan remained main buyers. Demand for gold in technology improved 2% year over year to 84.2 tons, marking the fourth consecutive quarter of growth.

Supply Declined in the Quarter

Total gold supply contracted by 2% to 1,146 tons in the quarter. Recycled gold supply declined 6% year over year to 315.4 tons and mine production was down around 1% year over year to 841 tons. Also, production in China continued to decrease for five consecutive quarters due to stringent environmental regulations. In Tanzania, an ongoing dispute between the government and Acacia Mining led to 15% fall in production, as well.

Gold Price Trends in Third Quarter

Gold price was within the $1,200-1,300 per ounce range for much of the quarter. While geopolitical tensions between the United States and North Korea fueled the upside, it was later pulled down by a stronger dollar on expectations of the Fed hiking interest rates in December. Average gold prices came in at $1,277.9 per ounce, down 4% year over year.

So far this year, the Gold Mining industry has rallied 7.3% compared with the S&P 500’s gain of 15.9%. Going by the EV/EBITDA multiple (a preferred valuation metric for mining companies that have high capital expenditures), the gold mining industry has a trailing 12-month EV/EBITDA multiple of 7.28, lower than the S&P 500’s EV/EBITDA multiple of 11.33. The industry’s lower-than-market positioning calls for some more improvement in the near term.

What’s in the Cards?

While new mines were limited during the quarter, a number of new mines are expected to enter production in the fourth quarter. This might support mine production till 2018. Noteworthy mines include The Natalka project in Russia, Canada’s Rainy River project and Houndé in Burkino Faso.

On the demand side, we expect India to bounce back from the lull as the market adapts to GST. Pent-up demand and removal from the scope of PMLA legislation as well as festive buying are anticipated to boost demand for jewelry in the country. Even though the impact of uneven monsoon rainfall distribution on rural population remains a concern, measures taken by the government to deal with the scenario might be a savior.

Given the insatiable appetite for gold and the rising wealth of Indian consumers, demand is expected to remain strong. China is likely to experience solid demand too. This is because the the people therein consider gold as a natural medium for savings and diversification in the form of bars, coins or jewelry.

Even though hike by the Fed may dent gold prices in December, retail demand from Asia and geopolitical tensions is anticipated to continue supporting gold prices.

Investors interested in this space can consider the following gold stocks that have a solid Zacks Rank and have witnessed positive estimate revisions.

Golden Star Resources Ltd. (NYSE:GSS) can be a solid addition to one’s portfolio. The company has an average positive earnings surprise history of 33.34% in the trailing four quarters. The Zacks Consensus Estimate for 2017 has moved up 22% over the past 30 days and for 2018 the same climbed 7%. The stock has been up 12.7% year to date. It currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Sandstorm Gold Ltd. (NYSE:SAND) , a Zacks Rank #2 (Buy) stock, pulled off an average positive earnings surprise history of 33.33% in the trailing four quarters. While, the Zacks Consensus Estimate for 2017 has moved up 25% over the past 30 days, for 2018 the estimate moved north 40%. So far this year, the stock has gained 13.6%.

However, we suggest staying away from or getting rid of the stocks carrying a Zacks Rank #5 (Sell) like Eldorado Gold Corp. (NYSE:EGO) and Harmony Gold Mining Company Ltd (NYSE:HMY) . These stocks have witnessed downward estimate revisions.

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