Is Investing in Gold Still Reliable?

Kiran is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Agnico-Eagle (NYSE: AEM) is a gold mining company with mining and exploration activities across Canada, Europe, Latin America and the United States. The company owns one of Canada’s largest operating gold mines by gold reserves in Quebec, namely LaRonde, which has significantly contributed to its domestic and international expansion.

The company’s revenues and profits are primarily driven through the production and sale of gold in both dore bar and concentrated form. The other drivers include production and sale of byproduct metals such as silver, zinc, copper and lead.

Agnico-Eagle expanded from a one-mine operation to a five mine operation over the last four years with the commencement of its commercial production in Kittila, Lapa and Pinos Altos, Meadowbank, and Creston Mascota mines, which enabled it to achieve higher gold production each successive year.

The company is primed to realize its growth potential with the commencement of its commercial production at the La India and Goldex mines .

Quick Snapshot of the Financials

It should be noted by investors that 2012 was a good year for the company, as the revenues from mining grew 5 % to $ 1.9 billion. The increase in revenue was predominantly due to higher selling prices and sales volumes of gold relative to 2011.The cash flow from operating activities was at a record $696 million, up 4% compared to 2011.

However, during the first quarter of 2013, revenues dropped 11% year-over-year and the total quarterly earnings fell 70% compared to same quarter the previous year. Although, total quarterly production of gold increased marginally to 9183 ounces, up by 5% year-over-year, owing to the company’s successful M&A strategy.

According to the company’s first quarter report, the Goldex mine is expected to commence commercial mining operations ahead of its schedule, as against originally planned in the first quarter of 2014. The Goldex mine is expected to increase gold production by 20% over the next three years to over 1.2 million ounces of gold.

Industry outlook

The mining industry is highly capital intensive and is exposed to several risks, such as government policies, political conflicts, resource nationalism, environmental hazards, and unpredictable geological conditions.

However, the returns offered by the operations past the development stage adequately reward the heavy investment in the initial phase. During 2012, the average market price of gold was at a record $1,669 per ounce, a 6% annual increase. The upward trend of gold prices in 2012 was a culminated result of Europe’s financial crisis, China’s slow economic growth, and the US’ third round of Quantitative Easing.

However, gold prices have been on the decline recently. The continuing downward trend in the price of gold is attributable to a series of unfavorable factors such as the strengthening of the US dollar caused by monetary easing attempts in Japan.

In addition, the falling level of inflation across the world, coupled with the widespread anticipation of discontinuation in the Fed’s third round of QE have further influenced the decline in gold prices. Moreover, rising interest rates and Cyprus announcing its plans to sell off its gold reserves worth $534 million earlier this year did not help investor sentiment.

It should be understood, gold is generally a hedging tool against high inflation, and therefore, in a scenario where the inflation rate is consistently declining on the grounds of monetary easing, an investment in gold seems less and less sound.

Nonetheless, it is noteworthy that demand for physical gold has increased in markets such as India and China due to a drop in prices. This suggests that the price of the yellow metal will possibly stabilize in the medium- to long-term. Hence, long-term industry trends will probably turn favorable once again. 

Competitive landscape

Barrick Gold Corporation (NYSE: ABX) is a key player in the gold mining segment, posing tough competition to Agnico-Eagle. During the first quarter, the company’s revenue dropped 5.7% year-over-year and the net earnings fell 18%. The drop in revenue and net earnings was primarily driven by the falling average realized price of gold, lower sales volume and increasing cost of sales.

The company produced 1.8 million ounces of gold during the first quarter, down 4% relative to the same quarter the previous year. Its cash cost of production  was maintained at a low level amounting to $561 per ounce.

Although, the company’s performance has been affected by unfavorable trends, its balanced reserves and consistent efforts aimed at achieving a low cost of production have protected it against severe damage from the downward trend witnessed in the price of gold globally. In the wake of today’s challenging environment, the company has reduced its outlook in key spending categories in an attempt to focus on cost control, curtailing its total overhead costs by $100 million for 2013.

Moreover, it has announced a reduction in planned Capex to $ 5.2 billion, as against previously planned $6.3 billion. With a view to optimize its portfolio and to safeguard its position in the tough market conditions expected ahead, the company has decided to hive off its non-core assets including Barrick Energy and Kabanga.

Kinross Gold Corporation (NYSE: KGC) is yet another contender that poses a threat to Agnico-Eagle. Kinross posted robust first quarter results, as it managed total gold production of 648,897 ounces, which is an increase of 10% over the same quarter the previous year.

This was mainly due to production increases in its Tasiast and Fort Knox mines. The company’s continued focus on achieving cost reduction eventually enabled it to maintain a low cost of production per ounce at around $729. Further, the company reported a 5% increase in total revenue from sale of gold during the first quarter. Nonetheless, it experienced a decrease in operating margins by 1% year-over-year, bringing the reported net earnings per share down to $0.14 relative to $0.17 per share during the first quarter of 2012.

Going forward, the company expects to produce approximately 2.4 million ounces of gold during 2013 and focus primarily on controlling costs and capital expenditures, as the entire industry is relying on this strategy in order to report positive earnings.

Key takeaway for investors

The players in the gold mining industry may witness struggling days ahead owing to tough challenges posed by the global economic scenario. This calls for the company to focus and increase efforts on controlling its operating cost structure in order to sail through the low tide in the gold markets.

Agnico-Eagle ensures the generation of superior long-term returns for shareholders by focusing on increased production in lower risk jurisdictions, which is considered the primary threat associated with the gold mining industry.

Even though the macroeconomic environment suggests otherwise, I still advise investors to hold on to this stock, as it will yield high returns once the industry trends turn favorable.

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Kiran Gulati has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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