Will The Gold Market Continue to Cool Down?

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

The price of gold has started off the year on a negative note and has lost nearly 3.9% of its value (year to date). Moreover, gold hasn't done well in 2012. Is the big gold rally of 2006-2010 over? Is it time to change our way we consider gold as an investment that will sharply appreciate over time? Due to the weakness in the gold market, major gold companies have suffered from it, as it reflected in their financial reports. What's up ahead for the major bullion companies? Let's take a closer look at these issues and try and figure what is up ahead for both gold and bullion companies.

Safe Haven Investment Fall

Gold is considered a safe haven investment much like U.S long term treasuries. Furthermore, the long term yields and price of gold tend to be correlated. Since the beginning of the year, the 10 year treasuries yield increased by 0.23 percent point. The yield increased despite the FOMC's program to acquire long term securities at a pace of $45 billion each month. This program may have kept the price of gold and long term treasuries from plummeting. The upcoming publication of the minutes of the FOMC meeting from January could add some insight as to when will the Fed end its current asset purchase program. If the Fed will refer to this issue, it could pull down the price of gold.

Another reason for the decline in demand for safe haven investments is the signs of progress in the U.S economy including the rise in the manufacturing production, and housing. If the U.S economy will continue to rally, this could impede the progress of gold prices.     

Money Base Continues to Rise

Despite the point I have made above, the rise in the U.S money base in recent months is most likely due to the QE program implemented by the FOMC. Since the beginning of the year the U.S money base rose by nearly 5%. In comparison, during the same time-frame last year the money base increased by only 3%. As the U.S money base further rises, it could also raise the demand for gold as an investment against a potential devolution of the USD. Moreover, the monthly changes in the price of gold (lagged by two months) and changes in money base have a mid-strong positive correlation of 0.37. Based on this relation, the price of gold, assuming all things equal, will rise in the coming months. This relation, however, should be taken with a grain of salt and it could take time until the rise in the U.S money base will start to affect the price of gold.   

Gold Companies and Gold

If gold prices continue to dwindle, then leading bullion companies, such as Goldcorp (NYSE: GG) and Barrick Gold (NYSE: ABX), are likely to reflect it as their stocks will decline.  Since the beginning of the year, shares of Goldcorp fell by 7.9%; shares of Barrick, by 9.65%. Goldcorp hasn’t performed well in 2012 as the company’s revenues only inched up by 1.4%. Nonetheless, the company’s operating profitability remained high, but also decline last year from 49% in 2011 to 39% in 2012.

Barrick has done worse than Goldcorp: Barrick’s revenues rose by a small margin of 2.2% in 2012 (year-over-year) but its operating profit fell to $(747) million in 2012. This number, however, is misleading because it includes a provision of impairment charges of $6.5 billion. Out of this provision nearly $3.8 billion is related to goodwill changes in the company’s copper business. After controlling for this entire provision, the company’s operating profit rise to $5.7 billion which is still an 18.7% drop from 2011. Barrick’s operating profitability also fell from 49% in 2011 to 39%. If the price of gold will continue to decline, it will likely to cut not only these companies’ revenues growth but also their profit margin. For Barrick, 2013 won't be better than 2012 as the company’s projection for its total gold production is 7,000 to 7,400 thousands of ounces. In 2012, it was 7,421 thousand of ounces – a 3.3% drop compared to 2011. So the company expects to cut its production in 2013.

Even shares of Yamana Gold (NYSE: AUY) – another gold company that is expected to augment its gold production in 2013 by nearly 45% compared to its production in 2012 – have tumbled down in 2013 by nearly 12.2%. So even for a gold company that is expected to increase its revenues and production, has suffered from the weakness in the gold market.       

The Bottom Line

The decline in the price of gold might continue in the coming weeks but could change course if the demand for safe haven investments will start to pick up. Moreover, if the U.S economy won't show signs of growth and the money base will continue to rise, then gold price might rally. In any case, shares of gold companies are likely to further fall as long as gold isn't rising.  

For further reading:

What Could Impede This Gold Company?

Gold and Silver Prices Outlook for February 2013

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.


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