Gold has historically been a safe hedge against inflation. It would always be seen as an investment asset which is a safe hedging bet against other investment categories like stocks, bonds or real estate. The demand for gold is being mainly driven by consumer end demand to hold gold in physical form like jewelry or coins; or the demand could be from investment in instruments related to gold like ETFs or stocks of gold mining companies.
Historical gold Price Movement
Since the 2008 financial crisis, gold prices have doubled as gold is perceived to provide a crisis hedge when all other assets fail. Earlier to this Bull Run the world gold rates had risen at more or less a moderate rate over the years. If we see the prices of gold since 1970 we see that prices have been more or less constant with minor movements every 4-5 years. This trend was broken in the last decade where we see a huge appreciation in the prices which can be attributed to rising incomes worldwide. This rise is nothing out of the ordinary as it tracks the rise in prices across asset classes.
With easy monetary policy being followed by central banks and money being pumped in the economy in the recent years the price of gold have risen steeply, but in 2013 there are indications that monetary tightening would bring in the bull run in gold to an end. But at the same time concerns regarding the economy getting stronger are still there. A weakening dollar, disappointing data worldwide are giving a pessimistic view on the recovery of the world economy and in such a scenario I can safely say that there is still some steam left in the bull run of gold. It has a potential of reaching $2,000 per oz in a year or two before it takes a turn for a constant pricing or the Bear sets in.
But expecting a Bull Run similar to the last decade run would be naïve. In the immediate future do expect the prices to have a downward trend or expect a stability in prices before the Bull Run continues further for the next year or two.
The reasons supporting this stance are
- The Zero Interest Rate/ Near Zero Interest Rate Regime which the central banks have been following in the U.S. and Europe has to come to an end within a year. With rising Interest rates the abundant flow of money as seen in the last couple of years is bound to dry up which will lead to stabilizing or fall in prices of gold.
- Quantitative easing where the Central Banks are monetizing their debts would contract considering the inflationary pressure that the economies are bound to face. No economy can afford to print currency to monetize debt for an unlimited time period to uplift the economy.
These two factors, as and when will come into play will push the gold price down and stabilize it. One factor that can upset this equation would be Central Banks becoming net sellers again. Over the decade the Central Banks have been the net sellers of gold, but during the last couple of years these sells have virtually dried up. The Central Banks have now become net buyers, thus adding an upward pressure on the price of gold. This could be seen as a strategy for diversification in their foreign exchange reserves.
With the ever increasing demand of gold there has been an increase in production of gold too. In 2011 gold production reached an all time high of 2,810 tones. And surging demands do put in focus the stocks of gold Mining Companies.
Lets take a look at Kinross gold Company (KGC) to understand this.
Kinross is one of the top ten largest gold mining companies of the world. Kinross's proven and probable resources have grown from 24.7 M.oz to 62.6 M. oz from 2005 to 2011 a rise of 153% with full year production of 2.6 million ounces in 2011. This boost has helped to fuel the company's cash flow with its adjusted operating cash flow growing from $1.35 per share to $1.41 per share in 2011. With increased production and rising gold prices the revenue of the company has risen from $3,010.1mn in 2010 to $3943.3mn in 2011 which is a 31% increase in revenues and a 32% increase in margin per ounce sold.
There has been a significant increase in Production Cost of sales which has risen by 28% to $1,596 mn in 2011 from 2010.
In 2012 the company targeted a production of 2.5 million gold equivalent ounces and its cost of sales forecast was capped at $690-$725 per gold equivalent ounce. With the aim at cost reduction the company has identified $200 mn in capital expenditure which would add to its bottom line. The cost of production has risen to $677 per gold equivalent ounces as compared to 2011 but if quarterly revenue is seen there has been a drop of 7% quarter to quarter cost of production on account of higher production. This increase in the production cost has had an effect on the margin per gold equivalent ounces with a decrease of 5% in the 3rd quarter of 2012 from the same period in 2011. However, the net earnings per share have increased to $0.20 per share in 3rd quarter of 2012 from $0.18 per share from 3rd quarter of 2011.
With increased mine production, and demand being at all time high especially from the central banks, and probability of the bull run continuing for couple of more years, the stock, and gold in general, has the potential of outperforming itself in this financial year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.