Is There a Silver Lining For Another Gold Rush?

Gold Bars in Golden Bullion Shop

(Photo credit: epSos.de)

People have been trading gold for more than 200 years now. Gold is the one commodity that has remained attractive over the years with gradual gains. However, over the last few years, gold’s price rally reached new heights approaching the $2000 per ounce mark in August 2011. Nonetheless, this year has exhibited reverse characteristics, as gold plummeted to trade at around $1220 per ounce. Gold traded upwards of $1900 per ounce about two years ago, but now has lost about $700 since then. In fact, at the beginning of this year, gold was trading at about $1700 an ounce, which means it has shaved $500 in the last six months.

Why the shift in goal posts?

When gold hit an all time high of $1913 last year, there was a lot of speculation that the world could succumb to another global financial crisis. The Chinese economy had started showing signs of weakness, while Brazil, another BRIC country, struggled to replicate previous growth rates in GDP. Additionally, the Euro zone crises were beginning to threaten escalating to the rest of the world, while the U.S economy struggled to recover.

This prompted investors to seek havens for their money, where they could cushion against inevitable recession. Gold offered the best escape route, thus driving prices up. The U.S. Federal Reserve Board’s Quantitative Easing confirmed that the economy was indeed struggling leaving investors with no choice but to cover potential losses in investments in equity with long positions in gold.

However, since the beginning of this year, the U.S. economy has shown promising signs of recovery, with jobs data improving from one month to another. Federal Reserve Board chairman Ben Bernanke also hinted that tapering (cutting the level of quantitative easing) could be on the horizon. Some analysts also predict that tapering could begin as early as September this year. This has affected investors’ decisions with several of them now shifting to equities, in an attempt to ride on the recovering economy. This is what has pushed gold prices to levels witnessed in 2010.

Which stocks suffered?

ETF SPDR Gold Shares (NYSEMKT: GLD) maps the picture depicted by gold price on its trend in the last six months. The ETF is down 23.93% year-to-date. At the beginning of the year, ETF SPDR Gold shares traded at about $163 per share, but now are down to about $124 per share. However, the ETF now seems to be popping up another bubble on what analysts equate to Fed’s double speak on tapering.

Some believe that Bernanke’s speech did not ultimately rule out quantitative easing, which has resulted into some sort of recovery for the ETF SPDR Gold. Could this be a silver lining? Well, judging by the recent recovery some investors think so.

Barrick Gold (NYSE: ABX), based in Toronto, Canada, engages in the production and sale of gold and copper. The company’s stock price has suffered immensely with the declining prices of gold over the last six months. Barrick Gold is down 57.95% year-to-date, but has shown decent recovery over the last five days, rising 8%.

Approximately 85% of Barrick Gold’s revenues comes from Gold bullion sales, a unit that attracts a production cost of about $1000-$1100 per ounce. If we factor in operating costs, there is virtually little to claim as profit margins. This proves why the company announced last monththat it was trimming its operations staff of 400 by up to a third, in a bid to minimize operational costs.

Barrick Gold’s most recent quarter revenues fell by 6% from the same quarter last year. It operating loss margin of 8% indicates how the gold prices have affected its profitability.

AngloGold Ashanti (NYSE: AU), the South African-based gold producer, engages in the exploration, production, and marketing of gold and other minerals like sulphuric acid and uranium. The stock is down 59.29% year-to-date. Just like its rivals, AngloGold Ashanti suffers from declining gold prices. Gold Bullion sales and marketing accounts for more than 90% of AngloGold’s revenues.

The company’s cost of producing one ounce of gold stands at about $1300, which is above the current gold price. As of December 2012, AngloGold Ashanti’s cost of producing one ounce of gold stood at $1,078. This leaves little room for healthy margins, thereby putting the company under pressure on declining gold prices.

AngloGold Ashanti reported a 14% decline in revenues from its most recent quarter. The company’s operating margin stands at about 20% with a net income of $488 million, cumulative for the last four quarters.

The silver lining?

According to recent reports, China, despite its current economic troubles, has expressed a decent appetite for gold bullion. Reports indicate that China’s demand for gold almost equals global production. This indicates that regardless of the fact that the U.S. Federal Reserve Board may initiate tapering in the near future, the demand for gold in Asia and other struggling economies could offer a silver lining for recovery.

Additionally, for most of the companies, a majority of their gold sales do not come from the U.S. For instance, 44% AngloGold Ahsnti’s gold sales come from South Africa with Europe and North America accounting for 17% each. Nonetheless, the challenge is that gold is valued in U.S. dollars, which in the recent past, has continued to strengthen against major currencies.

The bottom line

Gold has probably gone through some of its worst periods in recent times. It would be unimaginable for the commodity to slide further from its current lows. The commodity trades roughly about $100 above production costs, which means a further dive, could push it below economic viability.

However, the increasing demand from China coupled by recent rebound of the ETF SPDR Gold could mean that after all, there is a silver lining for another rally, but definitely nothing close to the highs of 2011.

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