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Is Miners' Underperformance Creating Golden Opportunities?

Weaker ETF demand for bullion has been offset by stronger physical and official sector demand. Meanwhile, gold miners continue to lag bullion, but we see pockets of opportunity.

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Gold prices have been flat year to date after reaching an all-time peak in late 2011, as weaker exchange-traded fund inflows have led to modest declines in gold investment demand. Stronger physical and official sector demand for the yellow metal has helped to pick up most of the slack from weaker ETF demand, however, providing a measure of support for gold prices. While we think gold prices will probably remain strong over the near to intermediate term, we maintain our long-term forecast of $1,200 per ounce as current investment demand looks unsustainable over the long run, in our view. On the equities side, gold miners have continued their free fall in recent quarters, deepening their recent underperformance relative to bullion. We think valuation disconnects relative to bullion as well as higher dividend payments could help gold mining equities regain some ground; however, rampant cost inflation and heightened competition for investor inflows by bullion bars and gold-backed ETFs remain key downside risks for gold mining shares. Our top pick in gold mining is  Yamana Gold (AUY). Narrow-moat gold miner  Eldorado Gold (EGO) is another stock to watch for potential investment opportunities down the road once it clears its near-term operational hurdles. However, we are steering clear of overvalued  Goldcorp (GG).

Physical Demand, Central Bank Purchases Pick Up Slack From Weaker ETF Demand
While gold demand (and prices) steadily rose during the past decade on the back of surging gold investment demand, the elevator ride up has stalled more recently, as gold investment demand decreased for two straight quarters following its local peak in the third quarter of 2011 of 500 tons. Much of the slowdown in gold investment demand can be attributed to weaker net inflows into bullion-backed ETFs since the third quarter of 2011. ETF demand reached a peak in 2009 with 617 tons of gold and has steadily declined in subsequent years. However, continued strength in physical demand for the yellow metal, especially in the form of bullion bars, has helped to pick up the slack from flagging ETF demand and prevent a sharp drop in gold demand.

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