Environment seen remaining supportive for gold, juniors wait out the rain
The outlook for gold is rosy but the resource-mining sector remains a challenge, writes Liza Mayer.
The remarkable mix of financial, economic and political issues the world has seen over the past several years has created favourable conditions for gold, silver and other precious metals to thrive. Over the past ten years prices for these precious metals have risen — gold up five times in value, silver six times, platinum threefold and palladium a little over 50 percent.
2011 was yet another impressive year for these metals. Global gold demand rose to 4,067.1 tonnes, worth an estimated US$205.5 billion, according to the World Gold Council. This marks the first time global demand has exceeded the $200-billion mark and the highest tonnage level reached since 1997.
Despite the European debt crisis subjecting gold to some volatility — it hit $1,547.99 an ounce on May 15, its lowest since December 30 — many industry insiders and market watchers remain bullish about gold.
According to Rob Chang, an equity research analyst covering the metals and mining sector at Versant Partners, gold’s fundamentals remain strong despite the sentiments of a few bears.
“Because of the run up in gold prices over the past few years, some investors are of the view that there is limited upside and significantly more downside risk in gold,” he says. “As a result, these investors appear to have decided to ‘take the money off the table,’ take some profits, and invest elsewhere. However, we view this to be a speculative reason rather than a safe haven scenario. Fundamentally, gold remains an excellent safe haven since it does not carry geo-political risk and is a hedge against inflation.”
“Gold’s fundamental attractiveness has not changed. Our firm’s target price for gold this year is $1,775,” adds Chang. “We believe gold will remain resilient and be less volatile than the resource markets and overall equity markets. But like any other commodity, it will be vulnerable to the day-to-day news flow that appears to swing markets.”
Financial adviser, market analyst and author Peter Grandich, a sought-after commentator on the subject, is even more bullish about gold. “I concentrate on direction and not timing,” he says, when asked about his year-end target price for gold. “I’ve been willing to bet up to $2 million with any gold bear that gold will hit $2,000 without ever going to $1,000 but none have taken me up on that bet. So what I can say is $2,000 — and then some — is in our future and if it’s a matter of a few months or years, I’m not going to be discouraged on either possibility.”
INVESTMENT DRIVING DEMAND
The investment sector is expected to remain the main driver for gold demand this year. In 2011, gold investment demand topped 1,640.7 tonnes valued at US$82.9 billion, up 5% on the previous record set in 2010. India, China and Europe accounted for much of this demand.
“China and India are integral to the gold market,” Chang says. “Combined, the two accounted for 54% of global gold demand in the first quarter of this year. China surpassed India as the world’s number one consumer of gold this past quarter. In Q1 of 2012, Indian gold demand was 207.6 tonnes while the Chinese purchased 255.2 tonnes during the same period.”
Grandich notes that gold bears overlook the role China and India play in the gold market. “They have not begun to fully appreciate that not only is a significant part of the world’s wealth being created in these countries, but how the people in these countries much rather own hard assets than paper assets. And with my belief that India will be the next China, I continue to expect these countries to be net significant buyers of gold,” he says.
Grandich says other factors that have dramatically changed the supply-versus-demand picture in favour of gold include the fact that central banks, once predominant sellers who always capped the market, have become net buyers of the yellow metal. Gold producers have reduced or stopped hedging transactions; and the creation of exchange-traded funds or ETFs make it easier for institutions and private investors to buy and sell gold. “Until one or more of them revert back to their old ways, I don’t see how the rise in gold over the long term comes to an end,” he says.
JUNIOR RESOURCE SECTOR
But while the outlook for gold is rosy, it is a different story altogether when it comes to mining stocks, which have largely failed to keep pace with rising metal prices. On top of mining-specific challenges, the European debt crisis has added to a matrix of global economic problems that is taking a toll on mining stocks.
Grandich offers reasons junior gold mining shares have not moved in sync with gold prices, among them, the buying and selling of individual stocks through a full-service broker being all but over. “Mining companies, especially juniors, were heavily dependent on brokers getting behind their stocks and bringing their clientele in. Much of that buying is gone and has not come close to being replaced in another form,” he says.
Eric Fier, Chief Operating Officer of Vancouver-based precious metals producer SilverCrest Mines, believes the mining industry has lost a generation of investors savvy about the industry. “If you looked at this industry in the ‘80s there were a lot of sophisticated people that understood the mining industry and the values that should be applied to it. We’ve lost that generation; today there’s been little interest in following mining companies after dotcom and tech took over most of the US market. So one challenge is to educate the markets once again about what mining equities are all about.”
Chang of Versant Partners says the operating risks junior resource companies face curb investor appetite. One of these risks, he says, is the rising cost of exploring, developing and mining resources. “The reason for this is that mineral exploration and extraction work has been going on for centuries and the low hanging fruit has been found. It is difficult to find a large, high-grade deposit of anything in a safe jurisdiction. While this does occasionally occur, most of the new projects cost more because they are either smaller, deeper in the ground, lower grade, or are located in political jurisdictions that are either unsafe, under developed, or under threat of nationalization. These all increase costs.”
In an environment such as now where investors are very cautious, Chang says many prefer to hold the underlying commodity rather than deal with operating risks of a company or its financial stability, for that matter. “They certainly give up the exploration upside by doing so but it appears this is a trade-off many investors have been willing to take.”
Fier, whose company has put one mine into production in Mexico, believes it is just a matter of time before mining shares recover. “I don’t think anybody is fairly valued especially in our peer group right now given the global market conditions… The US is in an election year so with the election and all of the baggage it comes with done and over with in November, you’ll see some relief in applying some security into the markets and investors coming back in. There’s a huge amount of money in the sidelines right now that is waiting to come back into the market once there is some stability… We just have to wait these markets out.”
Although teeming with challenges, sources believe the mining sector remains rife with opportunities. “I don’t envy the typical junior resource CEO, but the fact still remains that much of the metals the world is going to need are still going to be discovered and developed by junior resource companies and the majority of those companies are Canadian,” says Grandich.
In British Columbia alone, there are some 1,200 exploration companies, most of them located in Greater Vancouver.
“There are always many junior exploration plays out there and they are necessary because this is a big planet and there are lots of places to explore,” adds Chang of Varsant Partners. “It is true that only a handful ever get to the size of a Barrick Gold. But part of that reason is because the companies that find something meaningful are acquired by the Barricks and Newmonts of the world. Indeed most projects will not be brought into production anytime soon. But they could be brought into production if the commodity price is high enough. There are many gold mines that are economic in the current gold price environment that didn’t have a chance five years ago.”
Indian gold jewellery demand slows, Chinese demand remains robust
A number of market forces converged to dampen demand in India, including the rise in import taxes on gold and the introduction of an excise duty on gold jewellery. The developments sparked a three-week nationwide strike among jewellers, resulting to a 19-percent decline in gold jewellery demand year-on-year to 152 tonnes. In May, however, the Indian government withdrew the new tax on jewellery and the market is reportedly responding positively.
Meanwhile, rising income levels and the Chinese New Year festivities in the first quarter helped drive gold jewellery demand in China to 156.6 tonnes, which is 8 percent higher year-on-year. China now accounts for 30 percent of global jewellery demand, making it the largest jewellery market for the third consecutive quarter.
“China and India have seen continuing economic growth and whilst China’s economy is expected to slow, it will nonetheless surpass the rates of growth in the West. As we previously forecast it is likely China will become the largest source of demand for gold in 2012,” said Marcus Grubb, Managing Director, Investment, at the World Gold Council.
“This growth story also extends to other emerging market economies and is reinforced by central banks’ continued buying of gold, as a diversifier and a preserver of national wealth. The current picture of the gold market is diverse and not withstanding a flight into US dollars and treasuries near term, we believe the fundamental reasons for investing in gold today remain very strong and compelling,” he added.