Metals and mining companies have had a rough 2015. Volatile markets, China’s slowing growth and a potential interest rate hike have impacted precious and base metals. Gold, typically seen as a safe haven in uncertain times, has failed to attract much investor interest.
Gold is a counter-cyclical commodity that has a negative correlation to equity markets. When uncertainty spikes, gold usually rises. However, in the current environment of constant ups and downs, even gold is suffering from uncertainty. Gold is down 4.43% for the year despite the S&P 500 being down 8.4% year-to-date. Metals and mining companies benefit from low interest rates and the Fed continues to pledge a move in 2015. The collapse in Chinese equities also has been worrisome. China is the world’s largest gold producer and second-largest consumer behind India. If that demand dissipates it could have serious implications.
Estimize covers 15 gold mining stocks, and fundamentals are not looking strong. That group is expected to show an earnings-per- share (EPS) decline of 47% in the third quarter of 2015 on a year-over-year basis, with revenues anticipated to fall 4%. Analysts expect Q4 results to improve to -8% for profits and 0.8% for sales (see “Digging out of a hole”).
The impact of interest rates and the Chinese equity market meltdown is amplified for base metals. Steel, aluminum and iron ore, unlike precious metals, are consumed within a year. Miners tend to do well when economies are strong and there is less uncertainty, often accompanied by contracting credit spreads and a flattening yield curve. Base metal prices are used as a proxy for global growth and the health of manufacturing. While they also benefit from low interest rates, fluctuations in China have had an immensely negative effect. Emerging markets, especially the BRIC countries (Brazil, Russia, India and China), have a positive correlation with commodities, and the relationship is stronger for net commodity exporters.
China is the world’s largest importer of commodities, making it the biggest driver of global demand, and it is also the largest exporter of steel and aluminum. At the same time, because China is the world’s largest importer as well, their economic slowdown decreased demand for metals, thereby weakening prices. Year-to-date, steel prices have fallen by 31%, and aluminum is down 15%. The S&P 500 Metals & Mining sector is expected to see Q3 year-over-year profits and sales drop 57% and 13%, respectively (see “Out of favor”).
On Sept. 28, Glencore, the London listed leader in global commodities trading, dropped 29% after Investec Securities issued a warning about the company’s debt. Glencore’s business model was built on China’s insatiable appetite for base metals.
It holds $3 billion in cash and roughly $30 billion of debt on its balance sheet, leaving little cushion for changes in the demand profile of emerging markets. Although Glencore has since recouped much of that drop, it does represent a canary in the coal mine.
So, when will gold prices recover? Perhpas when the dollar tops out. But many economists say the dollar will only max out when rates normalize. The dollar and commodity prices tend to have an inverse relationship. In the recessions of 2002 and 2008, commodities benefitted from the collapse in rates. The Fed has made clear its wish to raise rates this year, but that has been thrown into question with the weak September jobs number, adding to the uncertainty.