Is the Gold Market Heating Up?

In the past several weeks the gold market has slowly recovered as the price of gold reached its highest level since mid-April. Nonetheless, the demand for gold ETFs ETFs keeps slowly contracting. Is the gold market heating up? Also, how will the recent progress in the gold market impact the bottom line of gold producers such as Goldcorp (NYSE: GG) Yamana Gold (NYSE: AUY)?

Is the demand for gold picking up?

Despite the modest rally of the price of gold, the demand for bullion in leading gold ETFs such as SPDR Gold (NYSEMKT: GLD) and iShares Gold Trust (NYSEMKT:IAU) hasn’t picked up during the past couple of months — SPDR Gold’s bullion hoards declined by 0.7% to reach 798 tonnes; iShares Gold Trust’s gold holdings slightly fell by 0.5% to reach 163.2 tonnes.

Nonetheless, during the first quarter, ETFs and other similar investments nearly haven’t changed their gold holdings, according to the World Gold Council. The total demand was 1,074.5 tonnes — close to the demand in the parallel quarter in 2013. Based on the above, it seems the demand for gold as an investment hasn’t increased. This market’s silver lining could be the slowly growing demand for gold in jewellery. Last quarter, this sector’s demand grew by 3%, year over year. Most of this growth came from China, which continues to increase its demand for bullion. In India, the second largest importer of gold, its recently elected Prime Minister Narendra Modi might change India’s policy and cut down the high import tariffs on gold. These developments could increase demand for the yellow metal and may have some positive impact on prices.

 

Prices are still lower than last year’s levels

On a quarterly basis, the average price of gold (for the second quarter and up to date) is only $1,285 per ounce, which is nearly 9% lower than in the same quarter last year. Moreover, the average price of silver is set at $19.5 — close to 16% below last year’s average price. Therefore, the lower quarterly prices are likely to keep down the profit margins of leading gold producers. The chart below shows the changes in the gross profitability of Goldcorp and Yamana Gold and the quarterly price of gold in 2013-2014.

gold price profit margin

Source of Data: Google finance and CME

As you can see, both companies have presented narrower profit margins in the past quarter compared to last year. But the stabilization of gold around $1,300 could maintain these gold producers’ profitability close the first quarter numbers.    

Currently, Goldcorp uses the price of $1,200 per ounce for gold and $20 per ounce for silver for budgetary and asset assessment reasons. Yamana assumes gold at $1,300 per ounce. Since, the current prices aren’t far off from these levels; the company isn’t likely to revise its guidance about precious metals prices. Thus, last year’s huge impairments of mining interests and goodwill provisions aren’t likely to appear in the next quarterly earnings report. In other words, these companies won’t have, for now, to record additional losses to their assets and resources.

Foolish bottom line

The slowly rally in the price of gold isn’t likely to improve the profit margins of gold producers. But the potential rise in demand for gold in China and India could slowly bring gold prices higher.

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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.