Gold Miners Have Adapted to the New Environment

Earlier this week, the Federal Reserve reduced its monthly bond purchases by another $10 billion and gave an upbeat assessment of the economy. Not surprisingly, gold prices reacted negatively. However, going forward the gold market will be driven by physical demand from Asia, not the Fed. But while strong physical demand would provide a floor for gold prices, the winding up of the Fed's bond purchase program means gold would have limited upside potential.

It is therefore important for gold miners to adapt to the new environment by cutting costs. Barrick Gold's (NYSE: ABX  ) and Goldcorp's (NYSE: GG  ) first-quarter results indicate that they are already doing so.

The Fed continues to trim bond purchases
The Fed this week concluded its two-day monetary policy meeting. As expected, the central bank reduced its monthly bond purchases by another $10 billion to $45 billion. This was the fourth reduction to the Fed's bond purchase program. At the present rate, the Fed is likely to wind up its bond purchases before year-end. 

More importantly, the Fed also gave an upbeat assessment of the U.S. economy. In a statement, the Fed said that growth in economic activity has picked up recently after having slowed sharply during the winter, in part because of adverse weather conditions.

Gold prices slipped on Thursday after the Fed's statement. However, the precious metal steadied in Asian trading on Friday. As I have said in previous articles, the Fed will have less and less of an impact on the gold market as it continues with its tapering. Indeed, the key driver for the gold market will be physical demand, which will strengthen every time there is a sharp pullback in gold prices. What this means is that gold prices will have a strong support level. At the moment this level is at around $1,200 an ounce.

Miners reduce costs, adapt to the new environment
While gold prices have strong support at around $1,200 an ounce, they also have limited upside potential without the Fed factor. I noted in a previous article that the Fed could be replaced by the European Central Bank later this year as it looks to fight low inflation and possible deflation. A quantitative easing program from the ECB would certainly boost gold prices. However, despite the growing speculation, gold miners cannot take the ECB factor into account right now. For them, the focus should be to reduce costs and adjust to the new price environment. The first quarter results of major gold mining companies suggest they are already doing so.

On Thursday, Goldcorp reported a sharp decline in its first quarter net earnings. The company's net earnings fell from $309 million, or $0.38 per share, in the first quarter of 2013 to $98 million, or $0.12 per share, in the first quarter of 2014.

However, investors would have been encouraged by the company's low all-in sustaining costs of $840 an ounce for the first quarter. In the same period last year, the company's all-in sustaining costs were $1,134 an ounce. While all-in sustaining costs for full-year 2014 are expected to be between $950 an ounce and $1,000 an ounce, Goldcorp would be in a position to generate free cash flow if gold prices average more than $1,200 an ounce. That seems to be likely, given the outlook for gold prices.

Goldcorp's rival Barrick Gold, whose recent merger talks with Newmont Mining (NYSE: NEM  ) failed to materialize, also reported significantly lower all-in sustaining costs even as it registered a sharp decline in profit. Barrick had all-in sustaining costs of $833 an ounce for the first quarter and has maintained its guidance for all-in sustaining costs of $920-$980 an ounce for the full year.

Jamie Sokalsky, president and CEO of Barrick Gold, noted that the lower all-in sustaining costs demonstrate that the company's efforts to reduce costs are delivering tangible results.

Indeed, with the cost-cutting measures starting to deliver results, and given the outlook for gold prices, this might be a good time to look at the gold mining sector.

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