The dollar is growing stronger, and economic stability is once again in the forecast for the dollar. We should all rejoice - or should we?
While the recovering economy may sound like good news to many investors, investors of Freeport-McMoRan (FCX) have reason to wish otherwise. Forecasts for gold prices in June were down by approximately $44 and prices sunk to an 11-week low in the beginning of April 2012. While there is reason to be wary, I believe that gold is down, not out.
In August of last year share prices for Freeport-McMoRan hit a 52-week high of approximately $56.78 but fell to a 52-week low of $28.85 only two months later. Currently, the stock sells at approximately $36 a share.
Why is Freeport struggling? There are several reasons.
First, the Federal Open Market Committee released a report about the state of the economy. The report claimed that the dollar had been indexed higher than other currencies and reported that the federal interest rate would not rise anytime soon, especially as fears of inflation and a leveling off of consumer spending continue to persist. Many analysts and investors interpreted these findings as signs that an economic recovery is eminent. While news of a recovery is great for consumers and many businesses, it is not good for gold.
The increased demand we have seen for gold has been driven by fears of high inflation. Gold is often a safe haven for investors looking for refuge in the midst of a turbulent stock market. Therefore, the value of precious metals has decreased as individuals begin to invest in stocks and bonds, which will necessarily hurt gold mining companies such as Freeport-McMoRan. Competitors are not any better off. AngloGold Ashanti Limited (AU) and Gold Fields Limited (GFI) fell by 5% and 4.2%, respectively, in the beginning of May.
The recovering economy is not the last of the bad news for Freeport-McMoRan. China, its biggest market, is decreasing its copper demand, which, combined with the fall in gold prices, will hit the company particularly hard. In addition, a recent strike by Indian jewelers seems to have exacerbated the decreased demand for gold. While the strike has ended, it caused a backlog of gold goods in the market, and prices have dropped as a result. Prices will drop further as these factors combine to create a very shaky market for gold mining companies.
As if these factors couldn't be detrimental enough, Freeport's competitors are chomping at the bit to increase profits. Most companies see new exploration projects as a, and excuse the pun, gold mine. AngloGold spent $98 million in 2011 in exploration and has entered into a partnership with DeBeers that includes underwater exploration, increasing its exploration budget to $180 million. Similarly, Gold Fields has increased its exploration budget to $150 million this year with an ultimate plan to increase its reserves to five million ounces of gold. Coeur D'Alene Mines (CDE) already increased the amount it plans to spend on exploration projects by 67% this year alone and Goldcorp (GG) has been forming a variety of exploration partnerships and joint ventures to work in low risk areas with few jurisdictional challenges. Increased exploration and reserves will only serve to decrease global gold prices, especially if the market continues to shrinking and demand continues to shrink as the economy grows stronger.
It is worth noting, however, that investors in Freeport-McMoRan may see the exploration quests countered by a 30-year deal the company struck with the Indonesian government in 1991. The company maintains 90.64% ownership in the Freeport mines there, giving it a huge advantage over competitors trying to break into the market.
With all of these negative factors building up, you might think that sticking with gold won't pay off - but don't think about jumping ship just yet. There is still plenty of money to be made from gold. One troy ounce is still worth approximately $1,623 on the Comex, so gold is still clearly lucrative. Freeport also announced that it will pay a cash dividend of 31 cents per share in March, payable in early May. However, there are persistent doubts about whether Freeport will be able to do so again next year, especially considering the decline in copper demand from China.
Any investors should know that, on top of market factors such as increased supply and decreased demand, gold prices are much more susceptible to emotional and behavioral factors. Many people view gold as a precious commodity, a belonging rather than a mere material, such as copper. Therefore, the decreased demand for copper in China, with its struggling economy, could possibly be made up for in demand for gold if economic recovery in the States is not as rapid or widespread as the Federal Open Market Committee report foresees, or if individuals simply persist in buying gold as quickly as it becomes available on the market despite economic factors. In addition, even if the economy does get better, large supplies of gold may persist as a popular investment strategy, as it was in the years following the Great Depression. Gold has equal potential and frustration because it is often impossible to use past data to predict future behavior.
I believe that there are too many "ifs" and "maybes" to count Freeport out and not just down. While all gold mining companies are struggling right now, Freeport is unique in that, unlike its competitors, it has been able to provide a large payout to investors. In addition, it has a notable advantage on exploration and mining rights through its 1991 deal with Indonesia. Gold mining is still a lucrative sector and, although it's slightly more risky than other options, with a little luck, a large payout could come your way.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.