Is the Gold Market Heating Up?

What a recovering gold market means (or doesn't mean) for Goldcorp and Yamana Gold.

Jun 25, 2014 at 11:28AM

In the past several weeks, the gold market has slowly recovered, with the price of gold reaching its highest level since mid-April. Nonetheless, the demand for gold ETFs keeps slowly contracting. So is this gold market actually showing signs of life? And how will this recent progress in the gold market impact the bottom line for gold producers such as Goldcorp (NYSE:GG) and Yamana Gold (NYSE:AUY)

Is the demand for gold picking up?
Despite the modest rally in the price of gold, the demand for bullion in leading gold ETFs such as SPDR Gold (NYSEMKT:GLD) and iShares Gold Trust (NYSEMKT:IAU) hasn't picked up during the past couple of months. SPDR Gold's bullion hoards declined by 0.7% to reach 798 tons, while iShares Gold Trust's gold holdings slightly fell by 0.5% to reach 163.2 tons. 

Nonetheless, during the first quarter, ETFs and other similar investments have barely changed their gold holdings, according to the World Gold Council. The total demand was 1,074.5 tons, which was close to the demand in the parallel quarter in 2013. Based on the above, it seems the demand for gold as an investment hasn't increased.

The silver lining could be the slowly growing demand for gold in jewelry. In the last quarter, this sector's demand grew by 3% year over year. Most of this growth came from China, which continues to increase its demand for bullion. In India, the second largest importer of gold, recently elected Prime Minister Narendra Modi might change India's policy and cut the high import tariffs on gold. These developments could increase demand for the yellow metal and may have some positive impact on prices.  

Prices are still lower than last year's levels
On a quarterly basis, the average price of gold (for the second quarter and up to date) is only $1,285 per ounce, which is nearly 9% lower than in the same quarter last year. Moreover, the average price of silver is set at $19.5 -- close to 16% below last year's average price. Therefore, the lower quarterly prices are likely to keep down the profit margins of leading gold producers. The chart below shows the changes in the gross profitability of Goldcorp and Yamana Gold and the quarterly price of gold in 2013-2014. 

Gold Price Profit Margin

Source of Data: Google finance and CME

As you can see, both companies have presented narrower profit margins in the past quarter as compared to last year. The stabilization of gold around $1,300 could maintain these gold producers' profitability close to the first quarter numbers, however.   

Currently, Goldcorp uses the price of $1,200 per ounce for gold and $20 per ounce for silver for budgetary and asset assessment reasons. Yamana assumes gold at $1,300 per ounce. Since the current prices aren't far off from these levels, the companies aren't likely to revise their guidance on precious metals prices.

Because of this, last year's huge impairments of mining interests and goodwill provisions aren't likely to appear in the companies' next quarterly earnings reports. In other words, these companies won't have to record additional losses to their assets and resources, at least for now.

Foolish bottom line
The slow rally in the price of gold isn't likely to improve the profit margins of gold producers. The potential rise in demand for gold in China and India could slowly bring gold prices higher, however.

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Lior Cohen 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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