Gold Market: Safe to Invest
Thursday, March 17, 2022 3:00 AM

Precious metals are the metals that are viewed to be rare but have a high economic value. The higher relative values of these metals are driven by various factors like their rarity, use in industrial processes and their use as an investment commodity. The precious metal industry is a very capital intensive industry. The huge amount of capital is required to finance the heavy expenditure in production and exploration for long term survival. The metals which are highly considered to be as valuable are gold and silver, having high lustre and higher melting points than other metals. In this report, we are going to discuss about the gold market.

Gold market trading:
From ancient civilizations through the modern era, gold has been the world's currency of choice. In recent times, investors buy gold mainly to hedge inflation or  political unrest. The idea that gold preserves wealth is even more important in an economic environment where investors are faced with a declining U.S. dollar and rising inflation. When investors realize that their money is losing value, they generally start investing into the hard assets that has traditionally maintained  their value.

The reason gold benefits from the weak dollar is due to pricing of gold in US dollars globally. There are two reasons that can be studied to understand this relationship. First, investors who are interested to buy gold (like central banks) have to make transaction in US dollars. The  greater outflow of a currency leads to the depreciation in its value as global, and investors seek to diversify out of the dollar. The second reason has to do with the fact that a weakening dollar makes gold cheaper for investors who hold other currencies. This results in greater demand from investors who hold currencies that have appreciated relative to the U.S. dollar.

Investment in Gold: The metals industry is not vertically integrated like other industries such as oil and energy. In this industry, the companies that mine the gold typically do not refine it, and refiners rarely sell it directly to the public.  The industry typically encompasses three types of firms associated namely exploration, development and production. Gold is the most popular precious metal for investors. It is traded as a commodity, and as such, its price fluctuates on a daily basis in the commodity markets. Investment in gold can actually be made through bullion, mutual funds, futures, jewelery or mining companies.  Companies that specialize in mining and refining of the metal also get benefit from rising gold prices. Investing in these companies  is an effective means to make profits, and these companies also carry lower risk than other investment methods.

Barrick Gold Corporation (NYSE: ABX), for instance, remained in a strong financial position with the gold industry’s only ‘A’ credit rating on December 31, 2011, with a quarter-end cash balance of $4.0 billion and low net debt of $2.5 billion.  Full year production of the company was 7.77 million ounces at total and net cash costs of $457 and $341 per ounce. The Company expects 2011 gold production to be in a comparable range to 2010 at 7.6-8 million ounces at total cash costs of $450-$480 per ounce or net cash costs of $340-$380 per ounce. Capital project expenditures for 2011 are expected to be in the range of $2.1-$2.3 billion. ABX is the top ranked company in the United States in terms of a market cap of $53.8 billion, compared to the total industry market cap of $1,391 billion.

ABX has a tough competition from Goldcorp Inc. (NYSE: GG), having a market cap of $39.6 billion. Goldcorp is the fastest growing, lowest-cost senior gold producer with operations and development projects in politically stable jurisdictions throughout the Americas. Gold production of 689,600 ounces for the fourth quarter and a record 25.20 million ounces for 2010, compared to 601,300 ounces and 24.21 million ounces, respectively, in 2009. The 2010 revenues of the company were reported as $3,799.8 million, compared to $2,723.6 million in 2009. Net cash costs decreased to $274 per ounce for 2010, compared to $295 per ounce in 2009. Dividends paid increased to $154.4 million in 2010, compared to $131.7 million in 2009. The increase in the dividend pay-out of the companies suggests the reason why investors would be willing to invest in the gold producing companies.

Gold Companies Analysis:
Since, the net cash cost of $274 per ounce of GG is less than that of ABX’s $341, shows that GG has a better operating leverage, which means that earnings are more stable and less volatile to changes in the price of gold. Apart from the costs, investors should focus on the revenue growth of the companies as well as their debt levels. High debt puts a strain on credit ratings, weakening the company's ability to purchase new equipment or finance other capital expenditures. Poor credit ratings also give rise to the debt reckoning situation. The precious-metals companies are usually never analysed on a price-to-earnings ratio. In general, a high P/E means high projected earnings in the future, but all gold stocks have high P/E ratios. The P/E ratio for a gold stock does not really tell us anything because precious metals companies need to be compared by assets, not earnings.

The most popular and widely used ratio in the industry is market capitalization per ounce of reserves (market cap divided by reserves). The market forces determine the price of gold in the market. Hence, gold companies do not compete on price. However, there is a tough competition amongst the gold companies in order to acquire land. The backbone of a precious metals company is its reserves, and the only way to beef up reserves is to explore for good mining areas. Companies go to great lengths to discover gold deposits, and the discovery is on a first-come-first-serve basis. In terms of supply, the companies have to face abiding rules and regulation from governments. The supply of land is plentiful, but in the presence of high environmental risks, it is quite difficult for the companies to gain approvals and permits to mine the land.

Gold acts as a lender of the last resort to most of the central banks globally. Reportedly, the US has 8133.5 tonnes of gold reserves, 73.9 percent of national forex reserves. Investing in precious metals can be done either by purchasing the physical asset, or by purchasing futures contracts for the particular metal. Larger investors who wish to have direct exposure to the price of gold may prefer to invest in gold directly through bullion or by buying shares in some public trading company. Despite  the fact that gold no longer backs the US dollar or any other currency around the globe, it is still important today.

Political and economic uncertainty in any part of the world is another reality of our modern economic environment. Taking into consideration the tensions in the Middle East, Africa or elsewhere, investors typically look at gold as a safe haven during times of political and economic uncertainty. After the above overall discussion, it can be concluded that  gold is a diversifying investment, and hence, it is worth to own gold, regardless of worries about inflation, a declining U.S. dollar, or even protecting  one’s wealth.