Will Gold Recover from its Recent Fall?

The ongoing tumble in the price of gold in recent weeks has dragged along with it gold related investments such as gold producers stock and the SPDR Gold Shares (NYSEMKT: GLD). Will gold rally from its recent fall?   Will gold producers’ stocks recover from their downward trend? Let’s examine the recent developments in the gold market.

Is the Demand Going Down?

Despite the recent sharp fall in the price of gold in the past several weeks many analysts still claim the demand for the physical metal is still strong.

The decision of the CME to raise the cash deposit requirements on gold and silver contracts on April 15th may have been among the key factors for the sharp drop in the prices of precious metals that day. Since then, however, gold has slightly rallied. But the price of gold is still very low compared to the price it reached in the past couple of years. I still think that most of the gold rally in the past several years wasn’t driven by the demand for the physical metal but rather the demand for it as an investment. Gold was mainly bought by investors who wished to protect their funds against a potential hyperinflation or against a sharp devaluation of the USD against other currencies. Since none of these scenarios happened (although the USD did devalue against certain currencies such as the Aussie dollar and Canadian dollar), since the stock market is making a comeback, and since the cost of holding gold contracts sharply rose in the past several years, therefore the demand for gold, as an investment, tumbled down. I still suspect the strong demand for gold (the physical metal) in India, China and other economies is likely to maintain gold price from tumbling down further; at the same time, these countries’ demand won’t be enough to pull up the price of gold to its former high levels. But will the demand for gold in these countries remain robust?

In the coming months the demand for gold in India and China might start to dwindle: India raised the import tax on gold, which is likely to cut down the demand for gold. Moreover, the appreciation of the Indian rupee against the USD may have also curbed the demand for gold in India.

China’s economy continues to grow but at a slower pace. This could suggest the demand for gold in China will fall. Further, the Chinese Yuan also appreciated in recent months against the USD, which is also likely to adversely affect the demand for gold in China.

Gold ETF

The main investment instrument that is suffering from the fall in gold price is the ETF that follows it – SPDR Gold Shares. The ETF’s price fell since the beginning of the year by more than 13.8%. Moreover, the ETF’s gold holdings also sharply fell by 16.4% (year-to-date) and by 13.9% in the past couple of months. Due to the sharp rise in the redemption of the ETF’s shares, revenues of SPDR Gold sharply rose in the first quarter of 2013 (opens pdf) to $2.01 billion. In Q1 2012, the ETF’s revenues were only $330 million. If the ETF will continue to lose clients, it will have to keep repurchasing its stocks back. If gold price will continue to dwindle, investors are likely keep pulling out of this ETF.

Gold Royalty Companies

The recent tumble has hurt not only gold ETF’s but also gold royalty companies such as Royal Gold (NASDAQ: RGLD). Since the beginning of the year the company’s stock plummeted by more than 32% (year-to-date). Nonetheless, the company’s revenues rose in the first quarter of 2013 by 6.5% (y-o-y). The company’s operating profitability fell by nearly 4 percent points from 62% in Q1 2012 to 58% in Q1 2013. Its revenues grew mainly due to the rise in production in Andacollo and Holt mines. Moreover, the company still expects to increase its royalty revenues from gold production in the coming months. But the sharp drop in gold price will offset its revenues growth and is likely to slash its profit margin.

Gold Producers

The leading gold producers also suffered from the sharp drop in the price of gold: shares of Primero Mining (NYSE:PPP) fell by nearly 11% (YTD). The company managed to increase its revenues in the first quarter of 2013 by 5.2% (y-o-y). The rise in gold and silver sold (in ounces) was offset by the drop in price of gold and silver. Nonetheless, according to the company’s recent outlook for the year, it plans to augment its production in gold and silver by roughly 8% and 22%, respectively (y-o-y). Nonetheless, the company’s operating profitability fell from 42% in Q1 2012 to 34% in Q1 2013. The sharp drop in gold and silver price is likely to shrink even further the profit margin of the company. The company’s cash cost (of mining, per gold equivalent) is projected to remain around $620-$640 per ounce, but in the first quarter of 2013 its cash cost reached $719 per ounce.

Goldcorp (NYSE: GG), unlike Primero, reported in the first quarter of 2013 a drop of 16% in revenues (y-o-y). Further, its operating profitability fell from 41.6% in Q1 2012 to 31% in Q1 2013. This time not only the decline in the prices of precious metals pulled down revenues but also the drop in copper and silver sold. On the other hand, the company’s amount of gold sold rose during the quarter by 9%. Goldcorp also expects to augment its gold production by almost 12% in 2013 (y-o-y) while its copper and silver productions are projected to slightly fall. The company also has a high cash cost of production gold that is expected to reach between $1,000 and $1,100 per ounce. This could mean Goldcorp’s profit margin is likely to be slashed below Primero’s profit margin.

The Bottom Line

I think the price of gold is likely to further decline, which will pull down along with it gold related investments. Even the strong demand for the physical metal might start to weaken in the coming months and thus won’t be enough to pull up the price of gold.

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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.