Four reasons why softness in US economic data boosted gold stocks

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US Economy

 

Gold prices moved above $1300 per troy ounce level after Britain voted to leave the European Union. Investors’ demand for safe heaven increased, triggering a strong rally in gold. Moreover, the gold prices were gaining support from expectations that central banks around the world would increase monetary stimulus to avert economic damages from Brexit. The US Federal Reserves’ dovish stance has been major factor that helped gold regain its shine this year. Some experts earlier believed that US’ latest poor economic data does not seem to convince Fed for a rate hike later this month.

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Gold prices performance since the last few months (Source: Nasdaq.com)

Four reasons how US economic data drove gold stocks:

The US service industries grew at slower pace: The US service industries has expanded at the slowest pace in six years which led to the probability of the US Federal Reserve raising rates

also falling to 24% as per the June-July 2016 data. The Institute for Supply Management (ISM) reported that non-manufacturing activity index fell 4.1 percentage points to a reading of 51.4 in August 2016, the lowest since February 2010. The drop from July was the largest monthly decrease since the 2008 financial crises. Many companies noted a slowing in their business levels. The activities were also weighted down by decrease in employment and new orders measures. Inventories at services industries contracted last month as did backlog orders and new export orders.

Poor payroll for August: Nonfarm payroll increased by about 150,000 for August. Market expectation was of 180,000 with unemployment rate ticking down one tenth to 4.8%. July and August averaged 263,000 and private job growth in August was just 126,000. In addition to the below-expectation number, wage growth was reported to witness a set back with hourly earnings up just 3 cents and an annualized pace of 2.4%. The average work declined 0.1 percent to 34.3 hours.

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US Nonfarm payrolls data (Source: bls.gov)

Fall in PMI: The final market US Manufacturing PMI came in at 52 in August of 2016, down from 52.1 in the preliminary estimate and 52.9 in July. Output growth was unchanged from July’s eight-month high while new orders and employment slowed and input price inflation eased. Relatively subdued new order growth led to a weaker pace of staff hiring across the manufacturing sector in August.

Low yields on bonds: US bond had fell with policy-sensitive two years notes yield falling to 0.73 per unit. Low yields on bond have pushed the opportunity cost of bypassing bonds. This has made the precious metals investment more attractive. Nearly half of all gold and silver miners are currently paying dividend.

The expectation of interest rate hike typically boosts the dollar and weighs on safe haven investments including gold. On the other hand, a delay in rise in interest rate increases the demand for gold. The US Fed wants to start lifting rates but the recent poor economic data was seen as not supporting the US Fed to raise interest rates. The U.S. central bank is set to meet on Sept. 20-21, 2016, with the discussion about rate hike still on the table.

The spot gold prices had moved up to about US$1353.4 a tonne at the back of the above developments. At the exchange rate of US76.7 cents, there are reports that Australian gold miners received around A$ 1764 an ounce while making huge profits.

Gold stocks have been cheap as compared with the gold prices and to equity market. This provides huge upside potential. Gold has risen about 27% since December 2015 till August 2016, the Gold Miners ETF Market Vector Exchange –traded fund (GDX)- a good gauge of investor interest in the mining sector, has rallied about 120% year in August. The market veterans have even said that if gold went up from its January lows to $1700, there are likely chances that gold shares would rise 2 to 3 times more than the physical gold. This has been witnessed in the past too between 2001 and 2010. Moreover, the junior mining sector is appealing from risk reward perspective. The risk is substantial for junior gold and silver mining stocks but the upside is also substantial.

At present with a change in the scenario, the U.S. Federal Reserve is expected to raise rates as early as this month following comments that came in from the central bank officials last week. Spot gold on September 12, 2016, held steady at $1,328.06 an ounce (at 0425 GMT) while U.S. gold futures slipped 0.1% lower at $1,328.30 an ounce. SPDR Gold Trust is also reported to mention for a fall in its holdings by 1.12% to 939.94 tonnes on September 09, 2016.

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