Last week was a disappointing week for the gold price. It fell from US$1,316 per ounce to around US$1,258 per ounce, which is a decline of 4.4%. This was bad news for gold producers such as Northern Star Resources Ltd (ASX: NST) and Newcrest Mining Limited (ASX: NCM). Their shares slumped by 17% and 7% respectively. In my view, Northern Star's outlook is uncertain even though it is improving as a business.
US interest rates
The fall in the price of gold last week could have been worse. It was given a boost by US jobs numbers on Friday which missed forecasts. The US economy added 156,000 jobs in September, which was less than estimates of a gain of 172,000. The jobless rate unexpectedly ticked higher to 5%. This means that the chances of a US interest rate rise are reduced in the short run. It points to a US economy which may be too fragile to sustain higher rates. Stubbornly low inflation and a disappointing pace of output growth in the first half of the year back up this viewpoint.
However, in my view interest rate rises are inevitable. The Federal Reserve may not raise interest rates before the end of the year, but the majority of US economic data remains upbeat. For example, manufacturing data and US services sector data were strong in September.
An interest rate rise would be bad news for Northern Star because it would make interest-producing assets more appealing relative to gold. This could cause demand for gold to fall and push its price downwards over the medium term.
An improving business
Northern Star has become an improved business in recent years. For example, in the 2016 financial year its all-in sustaining costs continued to fall. They averaged $1,041 per ounce and could fall further following the sale of the Plutonic gold mine. That's because Northern Star's remaining four key operational centres have significant production and exploration scale. This could boost Northern Star's reserves over the medium term following its 33% rise in reserves in the 2016 financial year.
Further, Northern Star has sound finances. It has no bank debt as well as a cash pile of $326 million. This reduces its risk profile and will allow for greater investment over the medium term as it seeks to increase production to 600,000 ounces per annum by 2018.
Outlook
However, Northern Star's focus on gold means that it lacks the diversification of other resources companies such as BHP Billiton Limited (ASX: BHP). This equates to a higher risk profile for Northern Star. Its valuation also lacks appeal. For example, it has a price to book ratio of 5.1 versus 1.5 for the materials sector. Alongside an uncertain outlook for the gold price, this makes it a stock to avoid in my view.