Gold miners fell sharply on Wednesday after comments from the new Federal Reserve head spooked gold market. Shares of miners such as Goldcorp (NYSE:GG), Kinross Gold (NYSE:KGC), and Barrick Gold (NYSE:ABX) fell sharply as gold prices slipped on Wednesday. In early trading on Thursday, gold prices slipped to a three-week low. Indeed, the Fed's signal of an end to the era of easy money is bad news for the gold market. But, gold miners should not be worried as the fundamentals for the gold market are in fact getting better.
Yellen spooks market
The new Federal Reserve head, Janet Yellen, who chaired her first policy meeting and press conference on Wednesday, spooked the market after she signaled an end to the era of easy money sooner than anticipated. As expected, the Fed continued its tapering, bringing down its monthly asset purchases to $55 billion. This was likely after February's nonfarm payrolls data beat forecasts and indicated that the previous misses were due to the severe weather conditions, which slowed down economic activity.
What took market participants by surprise were Yellen's comments on interest rates, which have been at record low levels since the financial crisis of 2009. Yellen said that the Fed is likely to end its bond purchase program by this autumn and could start to raise interest rates six months later. That would be March or April 2015, which is a few months before the Street's expectations of a rate hike.
Gold has been one of the biggest beneficiaries of the Fed's easy monetary policy, rising to record high levels in 2012. The precious metal's rally ended last year as the Fed signaled that it will start tapering its bond purchases. With the Fed now signaling an interest rate hike sooner than anticipated, gold's inflation-hedge appeal has taken a further hit. Not surprisingly, gold miners fell sharply on Wednesday. Shares of Goldcorp fell 3.43%, Barrick Gold fell 4.09%, and Kinross Gold fell 3.23%.
In a previous article, I had noted that the outlook for gold mining companies has been improving. So has that changed after the Fed's move? Not really since the Fed going forward is not expected to be a key driver for the gold market. Going forward, the gold market will be driven by physical demand from China and India. The news on that front is encouraging, and has actually further improved the outlook for gold.
India takes a major step toward easing curb on gold imports
A mounting current account deficit and a weak currency had forced the Indian government to impose curbs on gold imports last year. India is one of the biggest consumers of physical gold. In fact, the country was only overtaken by China as the world's biggest consumer of physical gold last year. One reason why India fell behind China was the import curbs imposed by the government, which hurt demand. But, Indian policymakers have taken a major step this week, indicating that the import curbs could be relaxed further or even completely done away with.
The Reserve Bank of India, India's central bank, has allowed gold imports by five domestic private sector banks, Reuters reported.
The duty imposed by Indian policymakers to curb gold imports had faced severe criticism. It is likely that a stable Indian rupee and narrowing current account deficit might have prompted policymakers to take a step toward easing of curbs. Also, India faces an election next month, and it is expected that the center-right Bhartiya Janata Party (BJP) might form the next government. The BJP has opposed import curbs, and it is likely that they might completely do away with it if they get a majority in next month's election.
If demand for physical gold in India bounces back and remains strong in China, it will completely change the dynamics of the gold market. While we won't see the kind of price appreciation experienced during the era of easy money, we will also not see the kind of volatility seen in gold prices in recent years.
Steady cash flow generating companies
Miners would settle for lower but less volatile gold prices, in my opinion. As I have noted in previous articles, gold seems to have found a floor at around $1,200 an ounce as any weakness in price boosts physical demand, as we saw in China last year. Prices could trade in a tight range of $1,200 to $1,300 an ounce, if the Fed is out of the equation.
The key then for gold miners will be to control costs. They are already undertaking efforts as I have noted before. Goldcorp had all-in sustaining costs of $1,031 an ounce in 2013, and expects to bring down its costs to between $950 and $1,000 an ounce this year.
Barrick Gold expects to bring down its all-in sustaining costs to be between $920 and $980 an ounce. The key question is whether this is the right time to buy gold mining stocks.
Gold miners are turning from the high-growth companies of a few years ago to steady, cash flow-generating companies as they adjust to the new price environment. Analysts' estimates compiled by Bloomberg show that the nine largest mining companies will generate free cash flow in 2014 for the first time in three years. Given the developments on the physical side of the gold market, the investment case for gold miners is definitely getting stronger. But, I would recommend waiting till the second half of this year to get a clearer picture on how miners are progressing on their cost-cutting measures. Still, one thing is certainly clear: The fundamentals for gold miners are getting better.
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.