Will Gold Producers Continue Their Recovery in 2012?

The recent announcement of the FOMC to buy mortgage backed securities at a rate of $40 billion per month is something that many bullion traders had anticipated and has already started to pull up the price of gold. Will this rally continue in the months to follow? Let’s check what were the main changes in the gold market and how will they affect the major producers of precious metals.

The price of gold hasn’t performed well during most of the year despite its rally in the past several weeks. During August-September the price of gold rose by 9.8%, SPDR Gold Shares (NYSEMKT: GLD)) also increased by a similar rate of 9.5%. Major gold miners stocks also hiked during those months: Barrick Gold Corporation (NYSE: ABX) rose by 26.6%. Other bullion producers have also risen by similar rates: Yamana Gold, Inc. (NYSE: AUY) increased by 26.7%; Goldcorp Inc. (NYSE: GG), by 28.5%. One of main reasons for this recovery started soon after the publication of the minutes of the penultimate FOMC meeting that sparked the speculation regarding the next move of the FOMC and whether it will issue another stimulus plan. The U.S employment report, in which the number of jobs added was fewer than 100k also raised the expectations that the FOMC will issue QE3.

The FOMC decided to issue QE3 with out a time limit, as oppose to the previous quantitative easing plans. The Fed’s announcement of QE3 and it pledge to keep the short terms rates low at least until the mid-2015 didn’t surprise many bullion traders so there is a chance that some of these expectations were already priced into the price of gold.

Further, the anticipation for QE3 was long overdue and as I have showed in a recent post, there has been a spike in the Google search for the term “QE3″ during last year. This could suggest that the long anticipation for the announcement of QE3 was, at least partly, factored in.

There is a strong correlation between the development in the money supply and the price of gold: as the money base rises, the price of gold tends to increase. This suggests that the recent move of the FOMC to expand the money base by $40 billion per month will, by definition, raise the money base, which is likely to pressure up the price of gold.

There is a strong and positive correlation between the development of the gold producers’ stocks and the price of gold, e.g. during the year the linear correlation between Barrick and gold was 0.68. This means, that under certain assumptions the changes in the price of gold could explain nearly 46% of the volatility of the Barrick’s stock.

Barrick Gold Corporation and Gold Price  2012 correl

As seen, this correlation had ups and downs during the year but in recent weeks the correlation has risen and during the last month the correlation reached 0.74.

All these facts add up that if the price of gold will continue to rally it could keep pulling up the stocks of Yamana, Barrick and Goldcorp. So will gold continue to rise during the rest of year as it did during the past several weeks?

As I have stated above, I still suspect that most of the effect QE3 has on gold is already factored into it. Since QE1 and QE2 didn’t have a strong effect on inflation this could suggest that QE3 might have an even weaker effect on the price of gold.

If the price of gold will remain high at its current rate it might result in the raising the dividends of gold producers: currently, Barrick offered a yearly dividend of $0.8 which is nearly 1.9% yield; Yamana offered 27 cents per share that represent a 1.4% yield; Goldcorp’s dividend represent a 1.2% yield.

Therefore, I still think that the Fed’s decision will keep the price of gold high and may even further pull it up, but I don’t think QE3 will have a strong effect on gold as QE1 or QE2 did. This mean that perhaps bullion producers will enjoy from the high gold prices, compared to the beginning of year, but if gold won’t further rise it could curb the rally of bullion stocks.

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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.