Gold prices have hit a two-week low. The precious metal is now priced at US$1307 per ounce after falling by US$4 yesterday. This is bad news for gold miner Newcrest Mining Limited (ASX: NCM). In my view, the outlook for gold and for Newcrest is bearish due in large part to an improving US economy.
Interest rate outlook
The US dollar has firmed up in recent trading sessions thanks to positive economic data. The US purchasing managers' index beat forecasts and came in at 51.5 versus expectations of 51.4. The Institute for Supply Management's manufacturing index for September was 51.5, which was ahead of the forecast 50.4. This provides further evidence that the US economic recovery is continuing and it could lead to a rise in US interest rates.
Further, US jobs data is due on Friday. If the numbers are as expected and the US has added 174,000 more jobs to keep the unemployment rate at 4.9%, the chances of an interest rate rise before the end of the year will increase. This is likely to have a negative impact on the price of gold. That's because the opportunity cost of holding gold versus income-producing assets will increase.
A rising US interest rate will also cause the US dollar to strengthen. This will have a negative impact on the price of gold and could hurt Newcrest's financial performance. This is due to Newcrest relying on gold for 85% of its sales. That makes the company far less diversified than sector peers BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO).
Risks
Gold bulls will counter the above with a number of risks which the global economy faces. For example, the US Presidential election is a key risk to the macroeconomic outlook, as is Brexit and the performance of the Eurozone. If such risks were to bear fruit then as a perceived safe haven, demand for gold could increase.
However, these risks could already be priced in to Newcrest's valuation. For example, it trades on a P/E ratio of 39.8 which falls to 26.6 when using financial year 2018's earnings per share forecast. This compares to a P/E ratio of 13.5 for the wider materials sector. In my view, this indicates that investor sentiment towards Newcrest is high and the share price appears to lack a margin of safety.
The market expects US interest rates to increase from 0.5% today to 2.25% by 2020. In my view, this rise will act as a constant drag on the gold price and on Newcrest's financial performance. The company is in better shape than a few years ago thanks to generating efficiencies and cost cutting. For example, in the 2016 financial year Newcrest reduced its all-in sustaining cost per ounce by 2%. This helped it to reduce net debt by 27% to US$2.1 billion.
Outlook
The bearish outlook for gold combined with Newcrest's lack of diversity and high valuation mean that I think it is a stock to avoid. I feel that investors should look elsewhere if they wish to turn $10,600 into $8 million, as this investor did.
