For the gold mining industry, demand will remain strong in the years to come given the demand for jewelry, bars and coins as well as a safe haven investment. However, the industry remains saddled by a number of headwinds. Below, we discuss some of the key reasons and what investors in the gold mining sector can look forward to in the coming months and years:
Inherent Risks in the Industry
Gold exploration and mining is a time-consuming and expensive task. Given gold's scarcity and remote location of deposits, exploration for new gold 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 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.
Lack of New Projects, Production to Flatten
Annual mine production grew for the sixth straight year in 2014, edging up 2% to a record of 3,114.4 tons. Mine production grew 2% year on year to 729.2 tons in the first quarter of 2015. Mines that have been developed and became operational in recent years continue to add to the supply stream. However, the growth in supply from such projects continues to diminish and is likely to flatten in 2015 as the supply pipeline thins.
Some gold companies, including Barrick Gold Corporation (NYSE:ABX), Goldcorp Inc (NYSE:GG) and Newmont Mining Corporation (NYSE:NEM), are currently high-grading at certain mines. The high-grade portion is mined first as this increases the grade of the mined ore and lowers the cost per unit. However, it has its cons as it depletes reserves very quickly, thus affecting long-term supply.
Gold miners, grappling with far lower gold prices than in previous years and cost pressures, have not been in a position to invest in developing new projects in recent years. To name a few, companies including Anglogold Ashanti Ltd (NYSE:AU) and Agnico Eagle Mines Limited (NYSE:AEM) have slashed capital and exploration spending. Given the lack of new projects, mine production will eventually plateau in the next couple of years.
Restricted Margins
The price decline has added to the woes of an industry that was already fighting rising costs, labor issues, strikes, delays and/or the cancellation of projects. If prices fall further, margins will be constrained as the price of gold closes in on the cost per ounce of the companies. In the wake of falling prices, the industry would see a rise in the number of producers reducing output or even shutting down operations.
Costs are difficult to curtail beyond a point for long, so miners will only profit if gold prices rise in response to demand and other macroeconomic factors. Production cutbacks and mine closures would spell more financial pain for producers and investors, who have watched gold mining stocks slump.
Substitution with Cheaper Material in the Technology Sector
Demand for gold in technological applications dipped 2% to 80.4 tons in the first quarter, the lowest quarterly level, affected by sluggish economic conditions in key markets and substitution away from gold. Despite inferior durability, copper and palladium-coated copper have made vast inroads into the share of gold in the bonding wire sector and this trend will continue through 2015.
Gold also witnessed a decline of 11% in dental demand, The decade-long decline in the dental sector shows no sign of abating as gold continues to lose ground to ceramic alternatives, which have improved steadily in quality, strength and durability.
Recycling will Remain Low
Recycling activity will remain low in 2015, and might deteriorate further given that a large portion of near-market supply has been flushed out in recent years. Less distress selling may further suppress recycling volumes. Many collectors are struggling to source feed stock.
Rising US Dollar, Cheaper Oil
There is an inverse relationship between the trade-weighted U.S. dollar and the price of gold. The dollar is gaining strength against major currencies on the back of positive macroeconomic data, such as the improving job market and growing industrial activity in the United States. A stronger greenback will continue to keep gold prices under pressure.
Cheaper oil means lower inflation. This indicates gold would be affected negatively as it is usually considered a hedge against inflation. Low U.S. inflation is negative for gold stocks such as Goldcorp, Barrick Gold, Newmont Mining and Kinross Gold Corporation (NYSE:KGC)
Bottom Line
Rising U.S. dollar, lack of new projects and decline in recycling activity are some of the sector’s worst detractors. But what about investing in the space right now; are there opportunities for short-term investors overriding the headwinds?
Check out our latest Gold Mining Stock Outlook for more on the current state of affairs in this market from an earnings perspective, and how the trend is shaping up for this sector going forward.