More Room for Gold Miners to Fall
We continue to believe consumer demand means gold has a promising future, but there is still downside risk for the commodity and the miners in the near term.
Gold has remained relatively steady in the low- to mid-$1,300 per ounce range over the past few months, holding onto the massive gains from earlier this year. However, through mid-afternoon Oct. 4, gold has fallen more than 3% to roughly $1,270 per ounce as the U.S. Federal Reserve looks likely to raise rates by the end of 2016. As a result, gold miner stocks have fallen by roughly 10% or more.
Based on Fed Fund futures prices, the market is currently pricing in 55% probability of one rate hike and 8% probability of two rate hikes by the end of 2016. The market currently prices in 37% probability of no rate hikes through the end of the year, compared with roughly 60% just a couple of months ago. In addition, the latest Federal Open Market Committee "dot plot" shows most participants currently expect at least one rate increase by the end of 2016 and two hikes in 2017.
As we have stated throughout the year, we believe that the investment-driven rally this year had been built on a shaky assumption that real interest rates would remain accommodative to gold for an extended period of time. While we expect a higher interest rate environment will weaken the attractiveness of gold as an investment, we still believe gold has a promising future of consumer demand and forecast a nominal gold price of $1,300 per ounce in 2020. We expect that in the long term, Chinese and Indian jewelry demand will fill the gap left by investment demand. However, the rise of consumer demand will take time, which means significant downside risk in the near term.
As a group, gold miners remain relatively overvalued. While we see upside for Goldcorp (GG) at its current share price as the stock has traded off recently because of protests at Penasquito, we still think there's room for all gold miner stocks to fall in the near term. As a result, we recommend gold investors best wait for the dust to settle.
One company we are cautious on is Iamgold (IAG). Like most gold producers, it is highly leveraged to gold prices, which is exacerbated by its high all-in sustaining costs of roughly $1,000-$1,100 per ounce. At current gold prices, the company generates less cash flow than some of its competitors. Should gold prices weaken further, Iamgold may find itself having to make drastic decisions to protect its cash flow. We think shareholder value faces additional risk with the company's decision to hold gold bullion in lieu of cash for a material portion of its liquidity needs. Any fluctuation in gold prices will affect not only Iamgold's cash flows but also the value of its holdings.
On the other hand, Eldorado Gold's (EGO) high leverage to gold prices is partially offset by the company's position on the lower end of the industry cost curve. However, sustained, weak prices will seriously hamper the firm's earnings power. Furthermore, with the Vila Nova mine in Brazil and Stratoni mine in Greece producing other metals, the company would suffer from a drop in iron ore, lead, zinc, or silver prices.
Kristoffer Inton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.