Why Gold Miners Aren't Glittering

Last week, gold traded above $1,000 per ounce for the first time in 11 months. Though the precious metal has pulled back over the past few days, it was still commanding $965 an ounce this morning. (Last November, prices nearly fell below $700 per ounce.)

The rally in gold prices has not gone unnoticed. Last week, NPR's Marketplace did a story about how people are holding gold parties. These quasi-social events pay participants for their old jewelry and other related items.

Given the economic backdrop, it's not surprising that gold has risen. The financial system is in crisis, stocks are volatile, treasuries are in a bubble and other commodities have plunged.

What is notable about the rally in gold prices, however, is that the higher price is not translating into improved profit forecasts for the gold miners. In fact, quite the opposite has occurred with more full-year earnings estimates being cut than raised. Mining-Gold has a 4-week revisions ratio of 0.88 (37 estimates revised up and 42 estimates revised down).
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Relative to the vast majority of other industry groups, this revisions ratio is actually good, but it certainly does not reflect surging gold prices.

Rally In Gold Is Not Sending Profit Forecasts Higher

The disparity could be reflective of the fact that brokerage analysts expect gold prices to drop. This is important since gold companies seek to maximize the spread between mining costs and selling prices. If the spread is projected to narrow throughout the remainder of the year, then the current rally in gold won't help profits significantly.

The price of other metals is having an adverse effect on mining profits. In its recent conference call, Agnico-Eagle Mines (AEM) discussed how plunging zinc prices impacted their margins. For other companies, copper is a headwind.

Overall mining production is down, and it's possible that this is also influencing sentiment. Earnings estimates for companies that manufacture mining equipment have fallen dramatically over the past few months. Though there is not a direct correlation between gold company profits and demand for mining equipment, weakness in part of a sector can lower forecasts for other parts of the same sector.

Finally, the economy and global financial crisis are playing a role. Demand for jewelry has dropped globally. Emerging economies are struggling, which means citizens of those countries have less wealth to buy gold. And the tight debt markets make it difficult to obtain new funding for expansions.

Are Analysts Being Too Pessimistic?

Nonetheless, there is the possibility that brokerage analysts will be proven wrong. Throughout last year, brokerage analysts were behind the curve on projecting what price oil would command - both during the first-half rally and the second-half plunge. If investors remain fearful, more money could get allocated to gold.

Commodity prices are difficult to predict. Translating those volatile prices into profit forecasts is even more difficult.

It's worth noting that the brokerage analysts themselves are split on the profit outlook for some gold companies. For example, 3 analysts have raised and 5 analysts have cut profit forecasts on AEM over the past month. A similar split exists on Barrick Gold Corporation (ABX) and IAMGOLD Corporation (IAG), with 2 analysts raising forecasts and 3 cutting.

Complicating matters is the fact that many analysts have not changed their forecasts. Out of the 16 covering Goldcorp Inc. (GG), nearly half have not adjusted their projections during the past 4 weeks (8 have raised and 1 has cut). A similar situation exists for Eldorado Gold Corporation (EGO), with just 7 of the 13 analysts making recent changes (3 raised and 4 cut).

Related ETFs

Investors should be aware that most gold companies are small in size. In the market capitalization of the entire Mining-Gold group barely exceeds the value of Google Inc. (GOOG). An alternative method of trading the gold miners, either long or short, would be to use the Market Vectors TR Gold Miners (GDX). This is a weighted ETF that invests in gold mining companies with market capitalization greater than $100 million and average daily volume in excess of 50,000 shares.

Investing In Gold

Another alternative is to invest directly in gold or combine gold-related securities with mining stocks. Our partners, Casey Research, are experts in gold and all things-gold related. I encourage you to look at their advisory service, Big Gold.

Comments

[doubleguns:]

The miners lag the metal. The metal is just getting started in herky jerky moves once established as a new bull you can count on the miners.

Feb 26 04:10 PM

[joethebull:]

Gold is just going through a temporary correction for now, with the miners chopping around between resistence points. This should continue for a bit as the overall market attempts to rally in the near term. The signs of a fledling rally have been around this entire week, with not enough volume to make any significant moves and really break out. Eventually it should happen though, as we certainly don't have enough volume to push the market below its current resistence.

That being said, sometime around beginning to mid Q2 things will shift once again. The market rally will be over and the downtrend will continue. The flight to quality will be greater than before as the market plunges below the current lows. The gold rally will pick up full steam where it left off before, continuing to make higher highs, and the miners will soar.

The difficulty in assessing the strength of miners just depends on which side of the fence the assessor sits. They either buy into what I've just described, or they don't, and they evaluate the miners accordingly.

Feb 26 04:20 PM

[BxCapricorn:]

My theory is simple. Traders have very little to work with, and so moved into gold, knowing that this is the home of the last "buy and hold" investor. When oil recently bottomed, they started to shift out of gold and into oil. They'll push up oil for a week, and when something else bottoms, they'll run over there and try to ride the tide that they themselves create. The financial media, forever hunting for the next big thing, or the lone silver lining, aid and abet this process by duping investors into helping float the traders' boat.

Seems like only a month ago that we were all told that healthcare and solar power stocks are "the play" now that Obama and the Dems are in control. There is simply nothing logical about owning any piece of the market right now, other than inverse ETF's.

Feb 26 04:25 PM

[Gold Barron:]

1 week ago, everybody was scared and saying "Buy Gold". Now, for some reason because the price of gold has pulled back, it seems there are discussions about the price of gold going lower. As if 1 week means anything!!

The banks are still insolvent! Inflation is coming!! Protect yourself folks.

Feb 26 05:07 PM

[Mayascribe:]

If you were to read the latest transcripts for most miners, they pretty much all under"guess"timate what they will be able to sell an ounce of gold for during this quarter, and throughout the rest of this year. None that I have read have gold above $850 an ounce.

Further, their balance sheets reflect much higher energy costs than they will have to endure this year.

If gold, say for arguments sake, hangs around the $1000/ounce for the remainder of the year, just the cost savings in energy will make the balance sheets have the luster of, well...gold!

This article seems to occlude this very important point.

Feb 26 05:45 PM

[ROLEXROLEX:]

Another sell side research to save some skins, it will not work, COMEX soon will look like Christmas tree with sell orders flashing red on the pit.

Feb 26 05:53 PM

[Bruce Pile:]

BxCapricorn has a good point about this market being left to the traders. The long hold money is out and too afraid to get back in. So we're seeing whatever appears to be bottoming or breaking out getting some inflow until it has a menial gain and then they exit, chopping down any emerging trend. About the only thing starting to gather buy and hold money is gold and gold stocks. The traders are putting these through a round of profit taking, but then they should be a good corner of what otherwise is a nearly uninvestable market.

Feb 26 06:35 PM

[Sakata:]

I may be way off base here, but I suspect that the reason some analysts have it wrong is that they are trying to evaluate miners using traditional means. This just doesn't work. There are a huge number of variables affecting the profitability of an exploration company but many of them are somewhat nebulous. How, for example, do you evalution management expertise, a key factor in the success of a junior?

For producers the profit margins are affected in a big way by a relatively small change in gold price. For example, if production costs are $600 an ounce then profits increase by 100% when gold goes from $800 to $1000 ( a mere 25% change). I doubt many analysts are willing to bet gold will be much above $1000 in the short term, hence there low predictions.

Feb 26 07:35 PM

[dr wonder:]

Regarding the comparison of Google to the gold mining stocks, one might pose the question as to the true worth of Google. Personally, I'd rather hold gold mining stocks than Google, but as others have said repeatedly there are no certainties in todays markets. Let the buyer be aware of the risks being taken with every purchase and with every sale.

Feb 26 08:20 PM

[BxCapricorn:]

After re-reading the article, one thing jumped out at me. Analysts' estimates. We just endured two years of analysts being wrong, while working with brokerages to pump stocks, and the fact that they are pumping Gold stocks does not raise the hair on your arms, neck and back.....good god, man!

Feb 26 10:07 PM

[CLH:]

Mining stocks always seem to go up first and go down first. If You trade gold watch the stocks for the direction. Right now they are forcasting lower gold prices.

Feb 26 10:25 PM

[Conan the B...:]

ROLEXROLEX: You aren't starting out to well in your current incarnation.

Why not provide some positions you have taken.

Just to show you should be taken seriously.

Feb 27 01:37 AM

[Conan the B...:]

All of the ROLEXes look alike, must have been quadruplets.

Feb 27 01:51 AM

[Mad Hedge F...:]

ab d Gold finally hit a wall just above $1,000, and instantly melted $80. For many traders who got in just above $700 three months ago, it’s time to say thank you very much to Mr. Market and either wait for a substantial pull back, or go on to the next trade. It was taking increasingly larger purchases of physical gold by ETF’s and coins by individuals to push the price up. CME statistics showed the speculators’ position soared to a net long of 215,661 contracts ($21.5 billion). The SPDR Gold Trust ETF (GLD) added five tonnes of the barbaric relic to 1,029 tonnes in just one day. The turnaround neatly sets up a double top on the long term charts with the high set last year. It may take a couple of more runs, and more bad news, which seems in abundant supply, to get the yellow metal to a true new high.

Feb 27 08:41 AM

[traderstraffic:]

Gold and Silver shortage
Mints: Cannot keep up with demand, waiting list, backorders,
Buyers: Bought record amounts in the last two months
Market: Correction, stocks in mines going down
If this was the housing market
House builders: Cannot keep up with demand, waiting list, backorders
Buyers: No houses to buy, bought all the houses on the market, waiting list
Market: Correction, housing stocks going down

I think if you look at this way Housing stocks would be going to the moon. So why isnt gold and silver going up instead of correction, stocks going down. Can any one say MANIPULATION. Why play a manipulated market.

Feb 27 12:26 PM

[pansyed:]

There is a problem when anyone says GLD added gold. The transfers of gold cannot be and has not been verified or observed it just magically happens. There is no audit of the gold. So is it a paper transaction such as a derivative, a loan? What makes this an honest investment that does not make one think of Madoff?


On Feb 27 08:41 AM The Mad Hedge Fund Trader wrote:

> ab d Gold finally hit a wall just above $1,000, and instantly melted
> $80. For many traders who got in just above $700 three months ago,
> it’s time to say thank you very much to Mr. Market and either wait
> for a substantial pull back, or go on to the next trade. It was taking
> increasingly larger purchases of physical gold by ETF’s and coins
> by individuals to push the price up. CME statistics showed the speculators’
> position soared to a net long of 215,661 contracts ($21.5 billion).
> The SPDR Gold Trust ETF (seekingalpha.com/symbo...) added
> five tonnes of the barbaric relic to 1,029 tonnes in just one day.
> The turnaround neatly sets up a double top on the long term charts
> with the high set last year. It may take a couple of more runs, and
> more bad news, which seems in abundant supply, to get the yellow
> metal to a true new high.

Feb 28 11:48 AM

[Ian R. Camp...:]

To make a general statement that ‘brokerage analysts’ expect gold prices to drop makes little sense to me, as many expect it to rise (although the gold price has fallen about U.S.$50 since the article was written, being about $925 this morning). It is accurate to say the price of bi-metal production by gold miners has fallen, but unlike base metal miners who produce gold and silver as bi-metals resulting in what can be substantial cost credits to them, gold miners profits typically are not so influenced by bi-metal prices. Moreover, reduced production by base metal miners (which currently is happening) means less gold supply to the extent that is important to the gold price. So far as demand for jewelry dropping, I suspect that gold ‘safe-haven’ investment demand is more than offsetting that – and in any event both these things should be reflected in the gold price, and should not by viewed in isolation influence the stock market pricing of gold shares. My own belief, as a generalization, with respect to the market price of gold company shares is that they tend to follow both the short-term gold price and the general market – which two things are not always weighted in exactly the same way by investors on any given day or short-term time period. That said, there is little doubt the long-term gold price is a key driver that bears directly on long-term gold company share values, everything else equal.

Mar 03 10:03 AM