Does The Rise of Gold Help the Profitability of Gold Producers?

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The price of gold rose during the third quarter of 2012. It’s very intuitive to assume that the rise in price of gold will pull up the profit margin of major gold producers. Let’s examine the recent third quarter financial reports of the major gold producer and try to figure out what’s up ahead for the gold producers in the near future; let’s also see how the recovery of the price of gold during the third quarter affected the gold producers’ profit margin.

During last month, Barrick Gold (NYSE: ABX) and Royal Gold (NASDAQ: RGLD) haven’t perform well: Barrick’s stock declined by 3%, while Royal Gold tumbled 11.7%. In comparison, during October the price of gold declined by 3.1%; SPDR Gold Shares (NYSEMKT: GLD) fell by 2.9%. Nonetheless, the price of gold rose during the third quarter compared to the second quarter.

According to the recent financial reports of Barrick, the company hasn’t performed well during the third quarter of 2012. The company’s revenues declined by 13.5% compared to the third quarter of 2011. Its operating profit tumbled down by nearly 48% in Q3 of 2012 compared to Q3 of 2011. These results are likely to further pull down the company’s stock.

On the other hand, Goldcorp (NYSE: GG) has done much better than Barrick during Q3 of 2012. The company’s revenues rose by nearly 17.6% during the quarter compared to Q3 of 2011, and its operating profit increased by 18.7%. The operating profitability of the company remained stable at 47%.

Royal Gold, much like Goldcorp, has done much better than Barrick but also didn’t show much growth in its operating profitability.

Despite the rally in the average price of gold during the third quarter, the operating profitability of the major gold producers didn’t rise much at all. Furthermore, the operating profitability of Barrick has been declining in recent quarters. According to the third quarter financial report, Barrick’s operating profitability slipped to 32%. In comparison, in the parallel quarter of 2011 the company’s profit margin, as indicated in the chart below, reached 53%. 

<img src="/media/images/user_12845/barrick-royal-gold-operating-profitability_large.jpg" />

In regards to Barrick, three factors were responsible for the drop in the company’s profitability: during the recent quarter, the company sold much fewer ounces of gold than in the same quarter in 2011. The company sold 1,792 thousand of ounces of gold in Q3 2012; in comparison, during the third quarter of 2011 the company had sold 1,908 thousand of ounces of gold. This is a 6.1% drop in the sales. Another factor is the rise in the company’s cost of sales by 7.7% during the third quarter of 2012 compared to the same quarter in 2011. The third factor is related to the company’s impairment charges for its “asset write-down of an exploration property in Papua New Guinea” (pg 60 in the company’s Q3 2012 report).

S&P 500 and Gold Producers

The recent fall in the financial markets – including the S&P 500 index and gold prices – may have contributed to the decline in the stocks of major bullion producers.

As seen in the chart bellow, shares of Barrick and Royal Gold have decreased in the recent weeks.

The strong correlation between these companies’ stocks percent change and the S&P 500 index could partly explains the decline of these stocks. E.g. during the month the linear correlation between Barrick and the S&P 500 index was 0.58; the correlation between the daily percent changes in the price of gold and Barrick was 0.64.

<img src="/media/images/user_12845/gold-and-snp500-and-royal-gold-oct_large.jpg" />

The Fed’s QE3 Didn’t Help Gold Prices, for now

Following the highly anticipated announcement of the FOMC to launch another quantitative easing back in mid-September, the bullion market promptly reacted with gold prices rising that day. Soon after, however, the price of gold, along with other commodities prices and major stock indexes, resumed its downward trajectory and slightly declined in the weeks to follow.

Perhaps the upcoming December FOMC meeting might bring some new wind for the bullion market.  The concerns over the fiscal cliff are also likely to keep the price of gold high.

The main question remains: will the price of gold pull up during the last two months of the year? I still think the effect of QE3 might not be as strong as the previous programs were on the money base and the price of gold. Nonetheless, I suspect the concerns over the fiscal cliff and the effect of QE3 could slowly affect the price of gold in the months to follow.

The bottom line: I don’t wish to put all of the above-mentioned companies under the same umbrella because these companies clearly have different characteristics. In any case, the rally in the price of gold during the third quarter didn’t seem to affect the major gold producers’ profit margin. Based on this, even if the price of gold will only slightly rise again during the last quarter of 2012, it might not help these gold producers.

For further reading:

Gold and Silver Prices Outlook for November

Will Gold Continue to Dwindle?

liorc has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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