Shares of Golden Star Resources (NYSEMKT:GSS), a mid-level gold mining and exploration company that primarily operates out of Ghana, plunged as much as 19% during Wednesday's trading session following commentary from the Federal Reserve. The day got a little less painful for shareholders of Golden Star, with shares rebounding to finish lower by only 7.5%.
Around 2:15 p.m. EDT, the Federal Open Market Committee announced that it was leaving its federal funds target rate (which influences interest rates) unchanged once again. However, the FOMC also hinted that there's a decent chance it could raise the federal funds rate in December. According to a statement issued by the FOMC: "The committee judges that the case for an increase in the federal funds rate has continued to strengthen, but decided, for the time being, to wait for some further evidence of continued progress toward its objectives."
The reason this statement caused Golden Star Resources, as well as its fellow mining stocks, to dip relates to opportunity cost. Opportunity cost is the act of giving up a near-guaranteed gain in exchange for another asset that could potentially offer a greater reward. Right now bank CDs and bonds have rates of return that are often losing to inflation, meaning there's little opportunity cost to foregoing these assets and choosing physical gold, which has no yield. If, however, the FOMC increases the federal funds rate and interest rates rise, CDs and bonds become more attractive and gold potentially less attractive, which can hurt physical gold prices and thus mining margins.
It's important for investors to put today's big spike downward (and subsequent rebound) into perspective. Even if the FOMC decides to go ahead and raise the federal funds rate at its December meeting, which seems increasingly likely, the opportunity cost of forgoing bonds and CDs is still very low. In my opinion, gold could probably withstand 100 to 125 basis points worth of rate increases without seeing any real switching from precious metals to interest-based assets. In other words, today's move may have been a bit of an overreaction.
What's far more important for Golden Star Resources: its Wassa and Prestea gold mines. With gold prices up more than $230 an ounce since the year began, Wall Street is going to be looking for steady or falling all-in sustaining costs, expanding margins, and an improving bottom line. By mid-year, Golden Star was on track to meet all of the objectives it had laid out for 2016, so in this respect things are going well.
Substantial improvements in production and ore grade are also expected over the coming 12 months. Pre-commercial production at Wassa's underground expansion commenced in July, and Prestea's high-grade underground expansion should begin commercial production around mid-2017. This is great news as well for Royal Gold (NASDAQ:RGLD), since it ponied up $150 million (which includes a $20 million term loan) to finance both underground expansions. Royal Gold will receive a tiered amount of production at a purchase price that ranges between just 20% and 30% of spot gold for the life of the mine.
If Golden Star's mines can deliver as promised, then the company could be considered inexpensive at today's levels. Wall Street's consensus calls for $0.25 in full-year earnings per share by 2018, if everything stays on track. Of course, the risks of political instability, along with traditionally higher mining costs in Africa, still make this mid-level miner a potentially risky proposition.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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.