The sharp fall in the price of gold in recent days took by surprise many investors and analysts. I’ll admit that the plunge in prices of precious metals was surprising, and I didn’t think gold will fall so promptly. Nonetheless, I thought the price of gold would have started to come down when the market adjust to the Fed’s change in monetary policy (assuming it will change it in the near future). Based on the recent developments in the gold market, does this mean gold will keep coming down from its current level? Is the golden era of gold behind us?
Gold as Safe Haven
The notion of gold as a safe haven may have started after the Fed started its first quantitative easing plan back in 2008. Moreover, the weakness in the equity market (on account of the financial meltdown in 2008) and low long term yields of treasuries pushed investors towards gold.
I think another driving force may have been the speculation of many investors that the U.S will eventually go back to the gold standard. In case you think this might be a good idea, just look at the Euro Area – this region has the Euro as its own type of gold standard currency. Paul Krugman made this comparison. Basically, the Euro Area countries aren’t able to print money (even though the ECB has this possibility). This puts Euro Area countries, such as Spain and Italy, in a situation where they can’t print money even if they will need it to jump start their economy. This is a fair comparison as to why going back to the gold standard is a bad idea.
Is There a Reason for Concern?
In the past few years, the U.S equity markets recovered; the Fed’s plan to cut the long term yields with its asset purchase programs helped steer investors away from government bonds and into equity. The U.S inflation remained contained less than 2%. This reduced even further the concerns of investors might have had from a sharp rise in inflation.
The U.S dollar remained relatively strong against leading currencies such as Euro, yen and Canadian dollar: The decision of Bank of Japan to augment its asset purchase program drove the yen sharply down, which put the USD strong. The debt crisis in Europe kept the Euro weak against the USD.
Even though the U.S economy has shown some signs of recovery, it’s still soon to claim the Fed’s asset purchase program made any difference. Moreover, if the U.S government will continue to cut its budget, the U.S economy’s growth might change course and contract.
Gold as Investment
The main problem for gold was that it only has the potential appreciation over time as a return. When the gold price isn’t rising, the metal becomes less attractive as an investment. The sharp fall in the price of gold since the beginning of the month by more than 12% also pulled down the ETF SPDR Gold Shares (NYSEMKT: GLD). The ETF lost 16.3% of its value during April. Moreover, the ETF is keep losing ground as its holdings continue to dwindle. Since the beginning of 2013, the ETF’s gold hoards fell by 16%.
Other gold related investments took a hit in the stock market: shares of the royalty company Royal Gold (NASDAQ: RGLD) lost more than 36% of its value since the beginning of the year. Shares of the gold producer Goldcorp (NYSE: GG) tumbled down by 24%.
Nonetheless, Royal Gold still has a very high profit margin because it doesn’t produce gold mines only buys them and collects royalty payments for them. The company’s operating profitability was 60% during 2012. This means, even after the price of gold lost 16% of its value, the company’s profit margin is likely to remain in the black. But the recent drop in the price of gold might lead Royal Gold to cut back on its business developments or at least reevaluate them considering the slash in gold price.
The situation is much different for Goldcorp. The company’s operating profitability was lower than that of Royal Gold. In 2012 the company’s operating profitability reached 39%. The company’s total cost in cash ($ per ounce) to produce gold sharply rose in 2012 by 34% compared to 2011 and reached $874 per ounce. If the cost of production will rise again to a range between $1,000 and $1,100 per ounce, the company’s profit margin will likely to decline substantially considering the price of gold is currently around $1,380 per ounce.
Perhaps the only silver lining for these companies is that the sharp drop in their stock raised their dividend yield: Royal Gold’s current dividend yield is nearly 1.5%; Goldcorp’s is around 2.2%. This is one of the few advantages these companies have over holding gold or investing in gold ETF. Another advantage is that both companies are expected to augment their operations in 2013. If gold won’t fall any further and remain profitable these companies rise in operations might offset the adverse effect the price of gold will have on these companies’ revenues during the year.
The Bottom Line
The golden era of gold might be behind us but some gold companies such as Royal Gold might continue to be relevant. These companies’ profit margin and revenues growth are likely to dwindle, but at least they will offer higher dividend yield; as long as mining gold remains profitable, they are likely to remain in business. But the demand for gold as an investment is likely to keep falling, which will keep dragging gold price further down.
For further reading:
- Gold and Silver Outlook for April 2013
- What Could Impede This Gold Company?
- Will The Gold Market Continue to Cool Down?
- Gold and Silver Yearly Outlook For 2013
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.