Two Scenarios That Could Boost Newmont’s Stock Price
Newmont Mining (NYSE:NEM) is one of the largest gold mining companies in the world. However, like most gold producers, the company has been adapting to an environment of low gold prices. Gold prices averaged roughly $1,266 per ounce in 2014, as compared to $1,411 per ounce in 2013. [1]
The decline in prices has primarily been due to the fall in investment demand for gold due to strengthening economic conditions, particularly in the US. Gold as an investment is often viewed as a hedge against inflation and economic weakness, and investors typically shift towards other asset classes such as equities and interest-bearing securities with an improvement in macroeconomic conditions. With improving macroeconomic conditions, the Federal Reserve is expected to raise interest rates some time this year. Expectations of an interest rate hike in 2015 have played a role in the reduction in gold prices, and we have factored in similar expectations in our model. However, this is contingent upon the pace of economic and jobs growth in the US. If macroeconomic and jobs data improves at less robust rates than expected, the Fed may delay an interest rate hike or moderate the pace of its interest rate hike cycle. This would present an upside to gold prices, which would positively impact the prospects of gold mining companies such as Newmont.
Though short-term demand for gold will be influenced by expectations of an interest rate hike, long-term strength in gold demand will continue to be governed by the jewelry demand for gold, which constitutes roughly 55% of the global demand for the metal. [2] The jewelry demand for gold is positively correlated with economic growth, particularly growth in emerging economies, which account for the bulk of the jewelry demand for gold. If economic growth picks up faster than expected, there may be a significant increase in both gold prices and the demand for the metal, which would positively impact the prospects of gold mining companies such as Newmont.
In this article, we will take a look at how these possible scenarios would impact Newmont’s stock price.
Delayed or Moderated Interest Rate Hike
The Federal Reserve has been keeping a close eye on U.S. macroeconomic and jobs data. The Federal Reserve is expected to start its interest rate tightening cycle only if these metrics display consistent robustness. Whereas the unemployment rate fell to 5.7% in January, as compared to around 6.7% a year ago, the Fed is also looking at the pace of increase in wages. [3] Wages have risen around 2.2% on average over the last 12 months. [4] However, with a decline in energy prices over the past year, US inflation rates are comfortably below the Fed’s 2% target. [5]
If inflation rates remain muted or if other macroeconomic indicators falter, the Fed may push back its expected hike in interest rates. Alternatively, the Fed may choose to moderate the pace of increase in interest rates. This scenario would present an upside to gold prices. In order to model this scenario, we have factored in higher gold prices and margins in our stock price estimate for Newmont. This increases our price estimate by around 6% from $24.82 to $26.29.
See our analysis for the Delayed or Moderated Interest Rate Hike scenario here
Increased Jewelry Demand for Gold
The demand for gold can broadly be classified into demand for gold as an investment, demand for gold in industry, central bank purchases, and the demand for gold jewelry. The jewelry demand for gold is the largest component of the overall demand for gold, accounting for around 55% of the overall demand for gold. [2] The demand for gold jewelry is strongly connected to cultural traditions in many countries, particularly in China and India. In addition, the demand for gold jewelry is aspirational, and tends to rise with increasing income levels. China and India are the two largest consumers of gold jewelry, accounting for nearly 56% of the jewelry demand for gold. [6] The trends in gold consumption by these two countries will largely determine the trends in demand for gold jewelry.
China is the world’s largest consumer of both gold and gold jewelry. Private sector demand for gold in China stood at 1,132 tons of gold in 2013, out of which the demand for gold jewelry stood at 669 tons or around 59%. This accounted for around 30% of the global jewelry demand for gold. [7] China is characterized by robust trends in urbanization, and industrialization. These have led to rising income levels in China. As per estimates by Ernst and Young, China’s middle class population will grow to around 500 million by 2020, as compared to 150 million in 2010. [8] These robust trends in growth in income levels are expected to result in an approximately 20% growth in Chinese private sector gold demand to 1,350 tons by 2017, as compared to demand in 2013. [7] Jewelry demand for gold from China is expected to rise by around 17% to 780 tons in 2017. [7] India is expected to witness trends in urbanization and growth in income levels comparable to China over the same period. As per estimates by Ernst and Young, India’s middle class population is expected to grow from 50 million in 2010 to around 200 million in 2020. [8] This would boost gold jewelry consumption at similar rates to those anticipated for China.
However, these estimates of growth in gold consumption are contingent upon the pace of economic growth in these countries, particularly China. There are question marks about the pace of Chinese economic growth, with a slowdown in economic activity, particularly in manufacturing, dragging down the expected GDP growth rate to 6.8% and 6.3% in 2015 and 2016 respectively, from 7.4% in 2014. [9] However, if Chinese growth recovers faster than expected, it would provide a fillip to global gold demand. In addition, Indian GDP growth is expected to pick up in 2015 and 2016, partially due to the efforts of the reforms-oriented new government. [9] In the scenario of a faster than expected global economic recovery, driven by China and India, global demand for gold would rise at rates mentioned previously, which are higher than those currently factored into our model. In order to model this scenario, we have factored in a 2% upside to gold prices, around 4% higher shipment volumes and a corresponding increase in margins. This would increase our price estimate by around 14% from $24.82 to $28.28.
See our analysis for the Increased Jewelry Demand scenario here
Thus, these two scenarios may result in changed business conditions for Newmont which would have varied impacts upon Newmont’s stock price and EPS.
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- Historical Gold Prices, Kitco [↩]
- Gold Demand Trends 2014, World Gold Council [↩] [↩]
- U.S. Unemployment Rate, Trading Economics [↩]
- US economy adds 257,000 jobs in biggest increase since November 2008, The Guardian [↩]
- Near Fed majority backs June liftoff Yellen hasn’t yet endorsed, Reuters [↩]
- Global Gold Jewelry Market, World Gold Council [↩]
- New report predicts sustained strong gold demand in China in next four years, World Gold Council [↩] [↩] [↩]
- China and India: tomorrow’s middle classes, Ernst and Young [↩] [↩]
- World Economic Outlook 2015, IMF [↩] [↩]