Finally Some Good News for Gold Miners

Strong physical demand in China has created a floor for gold prices.

Feb 11, 2014 at 12:44PM

Gold prices have continued their excellent run this year, with the precious metal hovering around $1,280 an ounce. On Tuesday, gold prices were gaining ahead of new Federal Reserve Chair Janet Yellen's testimony before the House Financial Services Committee. Gold's latest spike, which has been caused by a weaker dollar, has also boosted shares of gold miners. Goldcorp (NYSE:GG), Barrick Gold (NYSE:ABX), and Kinross Gold (NYSE:KGC) are up sharply for the year. However, this is not the good news for miners. The good news is the strong physical demand in China, which seems to have created a floor for gold prices.

Gold's rally continues
After falling for the first time in 13 years in 2013, the consensus outlook for gold price late last year had been bearish. This was not surprising after the Federal Reserve announced that it will start tapering its bond purchases. However, turmoil in emerging markets, a slowdown in China and some weak economic reports from the U.S. boosted gold's safe-haven appeal and sparked a short rally. Of course, this has also meant sharp rise in gold miners. Year to date, Kinross Gold has gained more than 18%, Barrick Gold has gained more than 10%, and Goldcorp has gained more than 22%.

The latest spike in gold, which has pushed spot gold to its highest level in almost three months, has been caused by a weaker dollar, the result of a disappointing jobs report for January, which has in turn raised the possibility of the Fed slowing down its tapering. Any hint of a slowdown in tapering will push gold prices higher, which would please miners and bullion investors. 

Strong physical demand
On Monday, the China Gold Association reported that gold purchases by Chinese consumers rose an impressive 41% in 2013. The sharp rise in gold consumption meant that China has now overtaken India as the world's top gold consumer. Gold prices fell nearly 30% in 2013, and it is obvious that Chinese consumers saw this as a buying opportunity. This in a way changes the dynamics of the gold market going forward. The Chinese consumption data suggests that there will be a surge in demand for the precious metal from the world's second largest economy every time there is a pullback in prices. As a result, gold prices will find support at certain level. At the moment, that level seems to be around $1,200 an ounce.

India might bounce back
Gold demand in India also follows a similar pattern. Gold consumption rises when there is a sharp pullback in price and vice versa. However, this pattern has changed in recent times after the Indian government levied duty on gold imports in order to curb demand for precious metal and reduce its mounting current account deficit. The move from the Indian government, however, has been criticized as it has led to an increase in gold smuggling. Still, the Indian finance ministry plans to continue with imports for now.

India faces a general election in May, and opinion polls suggest that there will be a change in government, with the BJP-led National Democratic Alliance likely to come into power. The BJP has been critical of the import duty, and might do away with it if it is elected in May.

What to watch now
The strong physical demand from China gave support to gold prices last year and is expected to continue to do so if there is another price drop. A possible rebound in physical demand from India will provide further support to gold prices. This means that gold miners and investors will now have to focus on these two factors more than what the Fed is doing.

There seems to be a strong support level for gold prices at around $1,200 an ounce. What does it mean for gold miners? It means more clarity. While it is difficult to predict short-term movements in gold prices, two things are now certain. Without the Fed, gold will never reach the record-high levels it did in 2011 and 2012, and the strong physical demand from China, and possibly India, will provide support to gold at around $1,200. As a result, gold miners can now have a clear outlook for their margins.

Although the short-term outlook for gold miners still remains bearish, the longer-term outlook has improved slightly, especially if miners can reduce their costs. Miners are already making an effort to bring down their costs. Earlier this month, Barrick Gold and Goldcorp announced the sale of their respective interests in the Marigold mine in Humboldt County, Nevada. Marigold was a joint venture between the two companies, with Goldcorp holding a 66.7% stake. The mine carried all-in sustaining costs (AISC) of around $1,545 an ounce.

Both, Goldcorp and Barrick Gold will also release their quarterly results later this week. It will be interesting to see what guidance the two companies provide on their AISC. 

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Varun Chandan Arora 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.

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