The gold market has started to recover in the past several weeks: During August, the price of gold rose by 4.5%. This rally may have positively affected gold producer’s stock such as Goldcorp (NYSE: GG): Share of the company rose by 17.9% during the past month. Will gold price continue to rise? Is it time to reconsider investing in gold and gold producers?
Gold price and gold ETF
During August, the price of gold rose by nearly 4.5%. Silver spiked by 18.8%. This recovery has also reflected in the rally of leading precious metals’ ETFs: The price of SPDR Gold (NYSEMKT: GLD) and rose by 3.6%. One concern investors who own an ETF that follow a commodity is the potential roll decay that could result in a discrepancy between the performance of the ETF and the price of the commodity. This situation, however, isn’t the case for SPDR Gold. The chart below shows the normalized prices of GLD and gold during the year (up-to-date).
The recent rise in the price of gold has slowed down the decline in GLD’s gold holdings during last week. Nonetheless, the total gold holdings are still down for the month: The ETF’s gold holdings are 915.32 tonnes, which are nearly 1.3% below the gold holdings at the end of July and 32.24% below the levels at the beginning of 2013. The decline in gold holdings has also reflected in the drop in GLD’s asset value: current asset value is $40.28 billion, which is 23.2% lower than the asset value of $52.43 billion at the end of 2012. Let’s turn to the recent developments in the gold market.
What’s the Fed’s next move?
One issue could affect the future price of gold price is the Federal Reserve’s monetary policy. In the past couple of months, the Federal Reserve has hinted it may change in the near future its monetary policy – the Fed may taper its asset purchase program in the near future and not keep its program up to the end of 2014. This shift has already reflected in the financial markets: Yields of long term Treasury bonds have rallied in recent weeks – 10 year bond yield is getting close to 3%. Conversely, the price of gold has declined in recent months (up to the past couple of weeks). These developments are consistent with the market expectations that the Fed may taper QE3. If the Fed will actually move forward and start tapering in coming months, this could further pressure down gold price.
The chart below shows the changes in the price of gold and 10 year treasury yield.
One of the reasons people purchase gold is to hedge against a potential rise in inflation. I have referred to the issue of gold’s effectiveness in protecting you from inflation. Up to now, the U.S inflation has been stable at around 2%. This low inflation is despite the Fed’s expanding monetary policy, which made investors worried regarding a potential rise in inflationary pressures. If the Fed will taper QE3 by the end of 2013 or even 2014, the market expectations for rising inflation will diminish, which is likely to scale further back the demand for gold as a safe haven investment.
Several gold producers such as Goldcorp and Yamana Gold (NYSE: AUY) have benefited from the comeback of gold as these companies’ stocks bounced back in the past month. Nonetheless, these companies will face several challenges that could impede their progress. The three main issues will be: Price of gold, production, and cost of production. Let’s examine these three issues.
Price of gold
In the second quarter both companies have experienced a sharp drop in revenues and profit margins: Yamana’s revenues fell by 19.6% (year-to-year) and its profit margin declined from 27% in the second quarter of 2012 to 12% in the second quarter of 2013. Goldcorp’s net sales tumbled down by 17.8% and its profitability (after controlling for goodwill provisions) to 14%.
Most of these companies’ drop in revenues was due to the sharp decline in gold price: The price of gold was 11.8% lower in the second quarter of 2013 than in the same quarter a year back. In the third quarter of 2013, the price of gold (up to now) is 21.5% below last year’s price (third quarter). This means the adverse effect the price gold will be harsher on gold producers’ revenues and profitability than in the previous quarter (assuming the current average price won’t change).
Yamana’s management still projects its gold equivalent production will increase by at least 10% in 2013. Up to now, however, the total gold equivalent production increased by roughly 3.4% (year-to-year) during the first half of 2013. Therefore the company will need to augment its production in the second half of 2013 to reach its goals. Goldcorp expects to increase its production by at least 6% this year. Up to now, the company expanded its production by 14.3% (first half of 2013), which means Goldcorp is on its way to reach its goal.
Cost of production
In terms of costs, Yamana’s all in cash cost of production sharply rose by 10.8% in the first half of 2013 (year-over-year). The current cost production is $950 per ounce. If this trend is likely to persist, this company’s profit margin will further contract. Goldcorp’s all in cash cost of production is even higher at $1,279 during the second quarter of 2013 – a 21.5% rise compared to 2012. This means, the company’s profit margin is even slimmer than Yamana’s.
The decline in profitability could eventually lead to reduction in these companies’ dividend payment. These companies’ current dividend annual yields are 1.93% for Goldcorp and 2.31% for Yamana. Considering these companies’ high risk and volatility, their reasonable dividend yield offers something that holding gold or SPDR GLD doesn’t have.
Despite the recent rally of gold price, it’s still too soon to call it a comeback that will persist over time. The upcoming decision of the FOMC could determine the future trajectory of gold. Moreover, gold price is still low compared to the past couple of years. Finally, the current low gold price is likely to result in a decline in revenues and profitability of leading gold producers.
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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.