SPDR Gold Trust (GLD) has continued to move down. Short term, I don't believe we are going to see any change in direction but I see a pattern developing, especially in the mining industry that could be a catalyst for gold prices. Let's take a look at my thoughts on gold and what could possibly signal a change in direction for the yellow metal.
Gold Mining Companies and Increasing Gold Prices
This is the present state of gold mining companies: Capital expenses continue to rise and cash flow continues to remain tough to grow for these mining companies. For this reason, many of these companies have put the brakes on exploration and production, and are more focused on cost-cutting measures and looking for high grade ore in their present production. So what can happen long-term? Is this going to lead to less gold production and a rising gold prices?
Understanding the gold mining industry:
Joachim Berlenbach, fund adviser with Switzerland's Earth Resource Investment Group, painted a good picture for me of the natural resource industry. When I think of a business expanding, I think of increased production and the possibility of better dividends. But this is not the case for the natural resource industry. When a gold producer is looking to open a new mine, it is usually not to expand production but to maintain production levels where they are. But one of the big problems the gold mines are running into is that new mines usually have a lower grade yield because most of the high grade ore has already been tapped. Lower grade ore logically means a higher cost to take it out of the ground.
A higher cost to take the ore out of the ground because of lower grade could be an answer to the present problem that gold miners are facing. This "all in one chart" shows what it costs to produce and own some gold and includes a company's cash flow which may broken down as follows: operating cash costs, capex, exploration and finance costs, expanding capex, plus general admin.
If costs are presently sitting at $1,600 to produce an ounce of gold, there is no room for companies to increase cash flow. Just to maintain cash flow, gold is going to have to rise to $2,000 an ounce in a few years for companies to make breakeven. So what are companies going to do? They are going to have to reduce costs to become profitable again. Not only will they have to reduce admin costs but they will also have to try to figure out ways to lower the cost of taking gold in the ground. One way that they will do this is to focus on the high grade ore. If companies do this, it means in the short term we may see less gold pulled out of the ground. This is called "high grading."
If the amount of gold pulled out of the ground does not keep up with demand, then we could see this as a driving factor in gold prices going up. I can't say when this is going to occur but the picture sure looks like it is being painted. At around $1,600 an ounce, give or take, gold-mining companies have no motivation to open new mines. It has been speculated that there needs to be at least a 20% increase in the value of gold which will bring it to about $1,900 amounts in order to motivate companies to expand into an exploratory mind set.
Gold Mining Dividends
If you are an income investor have you ever wondered which gold mining stocks pay the best dividends? Barrick Gold (ABX) ranks highest with a dividend yield of 2.7%. Following is Nevsun Resources (NSU) with a dividend yield of 2.5%. Agnico-Eagle Mines (AEM) ranks third highest with a dividend yield of 2.2%.
Thoughts On A Gold Rally
At this point, the thought of a gold rally probably sounds humorous, but in order to see gold rally we first have to see it stop moving down. And I don't think we are going to see anything change this week as the US dollar remains positive while economic news also has a positive twist. This will keep investors focused on investing in stocks as the market inches its way forward. Gold movement will be largely dependent on the outcome of the Federal Reserves policy meet, which is held on March 19. Any negative outcome would hurt gold sentiment.
As everyone can see, now is not the time to buy gold. Viewing the gold ETF chart, I noticed it is using the 40 day moving average as resistance. Sometimes it moves above the middle Bollinger band but rarely touches the top. The recent low shows an oversold position in the RSI indicator but it has yet to push into bearish territory as it appears to be moving sideways with a slight bullish bend. It hasn't even touched the middle Bollinger band yet so I would not consider this a time for the ETF to turn around. The MACD indicator also is well below the zero line and appears to be staying there. For this reason, all indicators support the bearish pattern the ETF has been in since October and I don't see any signs of reversal or even a base yet.