Gold is rising like crazy again.

On October 18, the price of COMEX gold futures surged by 1.07% to reach $2736.4 per ounce. This is the first time in gold's history that it has broken through the $2700 mark, with a cumulative increase of 32% since the beginning of the year, marking the 34th historical high of the year.

The gold jewelry market is booming. According to media reports, the domestic prices of pure gold jewelry announced by Chow Tai Fook, Chow Sang Sang, and Guangdong CHJ on the 19th have surpassed 800 yuan per gram, hitting a new high.

Faced with such an extremely rare market situation, many investors openly express that they no longer understand gold completely. It seems that no matter what news emerges, it all turns into positive news. So, how can one seize the potential investment opportunities in gold?

01

From a medium to long-term perspective, the main pricing logic of gold includes real interest rates and global central bank gold purchases. From a short to medium-term perspective, gold is easily affected by the risk aversion effect brought about by escalating geopolitical risks.

In recent times, the global geopolitical situation has been quite tense. On the one hand, there are signs of the Middle East conflict escalating. Firstly, Israel recently killed Hamas leader Sinwar. Secondly, there is intense fighting between Lebanon and Israel, with Hezbollah in Lebanon stating that they have entered a new phase of confrontation with their Israeli enemy. Thirdly, U.S. media reports have stated that Israel's plan to attack Iran is 'ready.'

On the other hand, the situation on the Korean Peninsula has worsened. Apart from the tense situation between North and South Korea, according to South Korea's intelligence agency - the National Intelligence Service, North Korea has decided to send a special forces unit of 4 regiments consisting of 12,000 soldiers to Russia for combat.

The deteriorating situations in the Middle East and on the Korean Peninsula have been the main driving forces behind the continued rise in gold prices in recent days. Of course, the significant uptrend that started in July this year is also closely related to a major pricing factor for gold, which is the real interest rates.

According to the data, the real interest rates in the United States started to decline in July, while gold maintained an upward trend. The weakening of real interest rates is due to signs of weakness in core macroeconomic data such as US non-farm employment, indicating a slowdown in the US economy. Against this backdrop, the Federal Reserve implemented the first interest rate cut in 4 years on September 18, with a significant 50 basis points cut, exceeding market expectations.

The Federal Reserve also predicts that by the end of 2024, the Federal Funds Rate will be 4.4%, by the end of 2025 will be 3.4%, and by the end of 2026 will be 2.9%. Once the bow is drawn, there is no turning back. The Federal Reserve will enter a prolonged period of interest rate cuts for several years, it's just a matter of whether it will be quicker or slower.

Although recent US retail data exceeded market expectations, and initial jobless claims data was below expectations, causing the Federal Reserve to waver in the magnitude of the rate cut in November from the previous 50 basis points to the expected 25 basis points hike, it does not hinder the future trend of interest rate cuts. This will be one of the important drivers for gold to continue to strengthen in the future.

In 2022-2023, despite the significant increase in real interest rates in the United States, gold continued to show substantial gains, mainly driven by the frantic gold buying behavior of global central banks. However, this driving logic has weakened somewhat this year.

According to data from the World Gold Council, global central banks increased their reserve purchases by 6% to 183 tonnes in the second quarter, but are expected to reduce purchases by 150 tonnes for the entire year starting in 2023 and ending in 2024.

As gold prices continue to soar, the net purchases of gold by central banks worldwide decreased to 8 tonnes in August this year. The People's Bank of China, however, is more cautious. By the end of September, its gold reserves stood at 72.8 million ounces, unchanged from the previous month. This marks the 5th consecutive month of the People's Bank of China pausing its gold purchases after 18 months of continuous shareholding.

Central banks around the world have slowed down their pace of buying gold in the short term due to the sharp rise in gold prices, but the overall trend has not changed. This is because global central banks continue to increase their distrust of the US-dollar-dominated global currency system, and have concerns about the future expansion of global geopolitical conflicts. Gold, as a strategic asset, plays a crucial role and is increasingly recognized by central banks globally.

02

Looking ahead, the upward momentum of gold has not ended, with many international investment banks raising the target price for gold in the next 6-12 months to $3000. Therefore, besides participating in futures and physical gold investments, investors can also explore high-quality gold companies in the A-share market for asset allocation.

From the perspective of the gold industry chain, the upstream sector mainly engages in gold smelting and mining, with leading companies including Zijin Mining Group, SD Gold, Hunan Gold Corporation, Western Region Gold, and the downstream sector mainly involved in the production and sales of gold jewelry, with leading companies such as Lao Feng Xiang, Chow Tai Seng Jewellery, and Chow Tai Fook.

Among the leading companies in the upstream resources sector, Zijin Mining Group has the strongest competitive strength - achieving lower-cost mining capabilities compared to its peers. On one hand, Zijin Mining Group possesses mining technologies that its peers do not have or cannot achieve, enabling the extraction of benefits from low-grade ore. On the other hand, Zijin Mining Group is adept at utilizing cycles, acquiring assets at low prices against the trend, with gold resource reserves as high as 1322 tons (with a resource amount of 3528 tons, ranking first domestically).

With relatively lower extraction costs and the continued rise in the end price of gold, Zijin Mining Group's high performance has a solid foundation.

On October 18, Zijin Mining Group released its third-quarter report for this year. In the first three quarters, revenue was 230.396 billion yuan, a year-on-year increase of 2.39%, while net profit attributable to shareholders was 24.357 billion yuan, a year-on-year increase of 50.68%. In the third quarter, the company's copper and gold production increased quarter-on-quarter, with gold prices rising and copper prices falling, maintaining strong performance.

In terms of profitability, as of the end of the third quarter, Zijin Mining Group's sales gross margin reached 19.53%, hitting a new high since 2013. The net profit margin was 12.88%, an increase of 3.83% compared to the end of 2023, setting a new high since 2012. It is clear that the significant and continuous rise in gold prices has had a notable effect on profitability improvement. Moreover, starting in October, gold prices have continued to climb, and the operating margin is likely to remain at high levels in the fourth quarter, with further upward potential.

Based on good potential growth, both domestic and foreign institutions express their attitude with real gold and silver. As of September 30, the northbound funds hold 31.4 billion yuan of zijin mining group, ranking 10th in A shares. In addition, as of the end of June, public funds held 63.2 billion yuan of zijin mining group, accounting for 13.54% of the total share capital, ranking as the third largest heavily weighted stock, second only to kweichow moutai and contemporary amperex technology.

In addition to zijin mining group, sd gold ranks second in the gold industry in terms of scale. In the first three quarters of this year, the performance is also expected to be good. According to disclosures, the net income attributable to SD gold is expected to be between 1.85 billion yuan and 2.25 billion yuan, a year-on-year increase of 37.52% to 67.26%.

The continuous surge in gold prices is beneficial to upstream gold resource companies, while downstream gold jewelry companies face obvious operational pressures.

As the price of gold rises, it suppresses the demand for gold jewelry consumption. According to data from the National Bureau of Statistics, from April to September, the sales of limited gold and silver jewelry companies continued to decline, with year-on-year growth rates of -0.1%, -11%, -3.7%, -10.4%, -12%, -7.8% respectively.

In the period of April to May this year, chow tai fook's revenue declined by 20% year-on-year. Lao feng xiang also showed significant pressure in the first half of this year, with revenue of 39.959 billion yuan, a year-on-year decrease of 0.95%, and net income attributable to the parent company of 1.028 billion yuan, a year-on-year increase of 10.28%, with a significantly more visible marginal decline compared to the previous few quarters.

The capital markets have also responded negatively. From March of this year to date, chow tai fook's stock price has plummeted by a large 42%, while lao feng xiang has changed its face since April, dropping by more than 30%.

In fact, in addition to the soaring gold prices affecting the gold jewelry sales end, gold jewelry companies also face the dilemma of long-term growth weakness.

First, after significant expansion of gold and jewelry stores in recent years, the market is already relatively saturated, with a more noticeable decline in store traffic and business income. This used to be an important engine for the performance growth of gold jewelry companies over the past many years, but now they face significant pressure.

For example, China's largest gold jewelry enterprise - Chow Tai Fook, has started a wave of store closures this year, with a net closure of 88 stores in the first three months, signaling a turning point in the past high-growth performance. Future performance will enter a phase of slow growth, even stagnation.

Secondly, the macro economy is facing considerable pressure, with consumers showing a trend of downgrading non-essential consumption and paying more attention to cost-effectiveness. Against this backdrop, various gold trinket companies are engaged in a price war, focusing on processing fees, leading to a decline in profitability. Additionally, compared to gold trinkets, the diamond business with higher gross margin is also facing intense pressure from synthetic diamond prices, potentially causing a continuous decline in price levels.

In conclusion, the continuous surge in gold prices is more bullish for upstream gold resources companies, while presenting some bearishness for downstream gold trinket enterprises. Investment opportunities mainly focus on the upstream sector.

03

When investing in gold companies, one must also pay attention to potential risks and keep track of the market. On one hand, during this year's continuous rise in gold prices, many gold resource stocks have continued to rise, reaching a reasonable, even relatively high valuation level. For example, Zijin Mining Group's latest PB ratio is 3.75 times, ranking above the median over the past 10 years, closer to the upper limit range.

On the other hand, one needs to consider and judge the sustainability of the gold price increase. Will it continue to rise on an annual basis? Or will it plateau in the medium to long term after reaching a certain price level, similar to the period from 2013 to 2019? Currently, during the Fed's rate-cutting cycle, the upward trend in gold prices is not easy to end, but how much of the rate cut is already priced in the current price?

Overall, a relatively optimistic attitude can be maintained towards the leading upstream gold companies, because the important driver of performance - the expected continued increase in gold prices - remains unchanged. Plus, the recent overall market trend under stimulus of a comprehensive policy package is unlikely to end soon, which will help in the valuation repair of individual stocks. (End of full text)

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