Leading gold companies such as Goldcorp (GG) and Yamana Gold (AUY) haven't performed well recently, with their third-quarter revenues plunging and their profit margins narrowing. Will fourth quarter earnings tell a different story? And if so, will it be enough to pull the stocks back up?
To answer these questions we have to examine the main factors that will affect their sales and profitability: gold prices, production, and the cost of production. Let's start with the price of gold.
Prices
The slowdown in the gold market has taken its toll on gold producers. One of the reasons for the drop in gold prices is the fall in demand for gold as an investment. SPDR Gold Trust (GLD 0.60%) is the world's largest gold ETF with a market value of over $33 billion. This ETF also serves as a signal for the changes in the demand for gold as an investment. During 2013, the ETF's gold holdings fell by over 38% and by nearly 9% in the past three months.
In the third quarter the average price of gold was $1,300 per oz. In the fourth quarter, up to date, the average price of gold was $1,289, which is 3% lower than the previous quarter and 25% lower than the same quarter last year. Based on these numbers, assuming all things equal, Yamana and Goldcorp will suffer a 25% drop in gold sales. But the other side of the equation is the amount of gold produced. Let's examine the current expectations.
Production
In the third quarter, Goldcorp expanded its gold production by roughly 7%. The company slightly revised down its guidance for 2013 from its initial annual guidance: Total production is estimated to reach 2.65 million oz. This is a 10% increase in production compared to 2012. Based on the revised guidance and the performance in the first three quarters of 2013, the company is expected to produce 752,000 oz of gold in the fourth quarter. If the company's gold sales match the amount of gold produced, its gold sales (in oz.) could rise by 15% from the fourth quarter in 2012. This means the rise in gold sales will partly offset the tumble in gold prices. Nonetheless, revenues from gold are still expected to drop by roughly 10% during the fourth quarter.
Yamana has also augmented its gold production during 2013. During the first three quarters of 2013, the company improved its gold production by 4%, but its silver production fell by 8%. In total, Yamana's precious metals production rose by 2%. Due to the modest rise in production during the first nine months of 2013, the company's early estimates to reach an annual production of 1.32 million gold equivalent ounces -- a 10% increase compared to 2012 -- seem unlikely. For this goal to be reached, the company will have to increase its current production by nearly 40% compared to the third quarter of 2013. Therefore, it seems that Yamana will have a sharp drop in revenues, more than Goldcorp, in the fourth quarter. Let's turn to the changes in these companies' cost of production.
Production costs
Gold companies provide in their earnings reports their updated all-in sustaining costs; this measurement reflects their costs related to sustaining production. During the third quarter, Yamana's all-in sustaining costs for a gold equivalent ounce grew to $888. For Goldcorp, its all-in sustaining costs rose from $801 to $992 -- a 23% gain. The company expects the cost will range between 1,050 and 1,100 during 2013. Such high all-in sustaining costs are likely to reduce profit margins. Despite the sharp rise in production costs, these companies are working to reduce their all-in sustaining costs by developing low-cost producing mines. Until then, their margins are likely to further contract.
Profitability
In the third quarter, Yamana's profitability fell from 36% in 2012 to 20%; Goldcorp's profit margin fell to zero. The sharp rise in production costs and drop in gold price have cut down these companies' profit margins, which are likely to remain low in the near future. But down the line, these companies might succeed in cutting down their all-in sustaining costs by developing low-cost mines. Two of Goldcorp's current development projects are expected to be low-cost production. They are expected to start operating in 2014. Yamana's biggest gold mine El Peñón has one the lowest cash costs and is expected to expand its precious metals production in the upcoming quarter. These developments could slightly improve margins in the coming quarters.
Takeaway
The gold market hasn't done well in the past, and gold companies haven't done any better. These companies continue to improve their gold production, which slightly offsets the drop in gold prices. Moreover, the potential improvement in their production costs might also benefit their valuations. But these gold producers are still a risky investment: They have much lower profit margins than they had in the past and aren't likely to recover to their glory days anytime soon.
