We may finally be seeing the wind leave the sails of the gold mining sector after a spectacular start to the 2016 calendar year.
Running Ahead of the Field
The financial markets have been especially kind to gold miners this year. Especially for the smallest junior miners, returns have been absolutely off the charts, with year-to-date gains many multiples of 100%—what investors might call a “three-bagger” or “four-bagger.” For instance, the Market Vectors Junior Gold Miners Index (GDXJ) was up over 213% at its high point this summer.
Meanwhile, the leveraged gold miners ETF known as the Direxion Shares ETF Trust (NUGT) had returned over 900% YTD at its high point. (NUGT is a 3x leveraged ETF, meaning it triples the returns or losses of its underlying gold mining stocks.) They call that a “ten-bagger”! The baseball reference is fitting: if you stocked up on gold miners during the first half of 2016, you undoubtedly hit a home run with your portfolio.
However, these two ETFs were down 1.5% and 4.5%, respectively, during trading on Tuesday. You can also see from their year-to-date price charts that the sector has dipped during the last week or so of August.
Investment in the big miners is also waning. After similarly strong gains for the premier gold mining firms earlier this year, major institutional investment in gold miners is also beginning to cool off.
This may not necessarily be indicative of weakening fundamentals for global gold mining. A chart showing the average all-in sustaining costs (AISC) to produce an ounce of gold for a group of major firms reveals this below. (Note that many miners average under $1,000/oz for next year, a vast improvement over a year or two ago.)
Really, the drop we’ve been seeing in gold mining has more to do with expectations that the Fed will raise interest rates soon. Remember, miners are part of the broader economy in general and the resource extraction or commodities sector in particular; changes in the global landscape, like the stagnation and central bank experimentation of 2012-2015, can have a big impact on their operations beyond the price of gold.
One concern is that these miners’ rallies and higher valuations have been pricing in a sharply higher gold market. If a Fed rate hike pulls the gold market back a bit, even on temporarily, gold mining could be hit hard again.
It’s not entirely unexpected that a correction for gold mining stocks has arrived, though. The mining industry has outpaced the rise in the price of gold by fivefold so far this year: +130% compared to +26% for spot gold. Some regression to the mean could be anticipated.
Demand for physical gold and new mine production is still rather strong, nonetheless. This is partly evidenced by the surprisingly high level of Switzerland’s gold exports. Since no major Swiss companies mine a significant amount of gold, this is gold passing through Switzerland after being refined. Still, this shows freshly refined gold is in high demand—largely for investment purposes rather than jewelry, an uncommon trend. Investment demand for gold during Q2 2016 was the highest-ever on record.
Switzerland exported 78.7 tonnes of gold to London in July, while importing the most gold from UAE/Dubai ~38 tonnes pic.twitter.com/UrAyZr0VWo
— Ronan Manly (@ronanmanly) August 24, 2016
While demand remains strong, another long-term development in the industry mirrors the trend in crude oil. Both gold miners and oil producers face a similar predicament: there have been no major new discoveries of deposits and little new exploration. In the case of a gold mine, it takes 20 or more years to develop a mining operation at a site where a deposit is found. However, while crude oil is in a supply glut and demand is being siphoned off by other energy technologies, a slowing of gold production would actually support higher prices.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.