It's no secret that the inflation some predicted at the hands of the Fed's liquidity injection plan never materialized. The run that gold saw amid these fears therefore became unsubstantiated. Now the decline has started and will continue save some exceptional event.
Some, like me, argue that gold is more a measure of fear in an economy at a given point. That is a debate for another day, but can be briefly addressed by looking at volatility indices in the market, many of which are now at their lowest points in years. With volatility remaining low, another potential catalyst for increasing gold prices is removed.
The SPDR Gold Trust (NYSEMKT:GLD) is the largest physically backed gold exchange traded fund (ETF) in the world. Over the last year the fund has lost approximately 28% of its value. This decline further compounds a downtrend that began in September of 2011.
With the Fed remaining confident in inflationary projections, demand for the precious metal remaining tepid, and fears of a global financial collapse safely behind us, gold has little reason to move higher.
When poor macroeconomic conditions hit, sometimes the businesses operating in that sector can fare even worse. As price declines hit a commodity, those same numeric declines often hit the profit margins, translating into even larger percentage decreases in terms of earnings. The Market Vectors Gold Miners ETF (NYSEMKT:GDX) is composed of global gold miners of varying market caps. This fund has seen a 50% drop in just the last year based on significant earnings declines among the components. As gold prices continue to fall, look for losses from miners to outpace the actual metal's decline.
Unfortunately this trend isn't confined to just gold. The silver market functions in a similar manner to gold and therefore is experiencing the same dismal results.
The iShares Silver Trust (NYSEMKT:SLV) is the largest ETF that holds physical silver. This direct exposure has translated into a 34% decline in share price over the last year with little reason to abate. While silver plays a greater role in industrial applications, that was not the reason for the nearly 375% increase from Oct. 2008 through April 2011, nor will it be reason for stability going forward. The reason for the run was the same as gold: speculation based on inflationary projections -- projections that never came to fruition. Therefore, the inevitable decline comes as a result of this unrealized strategy.
As noted above, miners will fare even worse. The Global X Silver Miners ETF (NYSEMKT:SIL) is a compilation of global silver miners. As before, decreasing commodity prices are impacting profit margins, resulting in a 50% decline in share price over the last year.
Silver Wheaton (NYSE:SLW) is the largest holding in the silver ETF fund and one of the best run companies in the precious metal space. Their "metal streaming" strategy allows them to purchase up front the extracted gold or silver from a mine they do not own for a predetermined operating cost. This allows them some insulation from runaway operating costs and therefore more predictable earnings. However, their profit margins are still affected by decreased selling prices which have plagued the silver market for the past two and a half years.
Silver Wheaton's Q3 2013 report confirmed the dismal market conditions with little optimism for the near future. The sales price for silver was down 32% from one year ago and even though production was up 17% that wasn't enough to prevent a decline in revenue by 4% over that same period.
Analysts are projecting the decline in earnings to persist another 7% for 2014 as some companies they have contracts with (namely Barrick Gold) are facing delays, suspensions, cancellations, and ongoing labor disputes.
Whether it was inflation or fear that lead to the spike in gold and silver, both potential catalysts seem to be contained. As a result this will continue to put downward pressure on prices for these precious metals and further hurt those companies engaged in this sector. No matter how sound the business model is, as illustrated by Silver Wheaton, pain will inevitably come due to the macroeconomic fundamentals controlling the situation. It will be best to avoid these sectors until we see at least some price stabilization.
James Catlin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.