GOLD: THE OUTLOOK FOR THE MINING COMPANIES.

GOLD: 

THE OUTLOOK FOR THE MINING COMPANIES.

The gold had dropped significantly to its four-year low on 05112014; it caused a fear among the producers for they have lost their room for action due to the long but painful drop in precious metal prices. The latest drop in gold has augmented the fears that it could drop further to 1.000 USD, a price which is below the break-even point of many gold producers around the world.

This severe drop in gold prices came as the major gold mining companies had started to report grim results for the third quarter, presaging worse results for the last quarter. These results came despite the efforts from the same companies to reduce their costs.

The investors who lost money in this process are facing a tougher picture: the gold price may drop to 1.000 USD. And this probability scared the investors and consequently, they sold the whole industry.

When the gold dropped significantly, the major producers undertook to reduce their costs, augment their production efficiency and put into shape their financial statements. But as the gold prices are in a severe downtrend, the investor has the fear that there isn't much room left for additional cost cutting without reducing the production itself.

The severe drops seen in the share prices of major gold producers is a sign that the investor is leaving the gold and acquiring interest-bearing assets, despite the fact that some of these companies had posted good results that had beaten analysts' expectations.

The main cost cutting program for the major gold producers can be summed up as: reducing expenses, recording write-downs, stopping the work in some projects and selling some of their deposits. Such moves should bring the cost of producing 1 ounce of gold to less than 1.000 USD; even some of these major companies could force 900 USD.

Once the price reaches the bottom (if it ever happens), a limited rebound should take place where the gold price would reach 1.150-1.200 figure after which the price should stabilize for while in a narrow band of 1.250 - 1.400 USD; the gold mining stocks should follow suite. In the short run, the EUR/USD which trades at around 1.2500 may drift lower to below the 1.2000 figure thus forcing the gold to drop further towards 1.000 USD due to the inverse relationship between the two. But this should not last long and we should see a rebound towards 1.3000 or more which should have a positive impact upon the price of the gold.

When gold is rising, mining companies deliver to investors superior operating  leverage for their profits rise quickly. When they add an extra leverage such as debt, the mining stocks offer very good returns when the gold rises.  But when gold trades between 1.100 - 1.200 USD, the mining companies stop growth spending, continue cost reductions and dividends cuts. Once the gold drops below 1.100 USD per ounce, the equity value starts to diminish significantly.

When the gold mining company carries a lot of debt, it makes it less appealing if gold prices are stagnant or falling. But gold mining companies that have a better debt profile are generating more demand. And the lower the debt level, the better it is in terms of low cost production. Thus such a company is best positioned to withstand a gold price downturn.

Currently, the average cost of producing 1 ounce of gold is about 1.150 USD and the producers made plans in which they forecast 1.300 USD. Most of the producers have a production cost that is around or slightly above this figure and a prolonged lower figures in the gold price will force many gold producers to leave the industry (the bloodbath) and subsequently form the basis of a rise in the gold price due to the imbalance between supply and demand and of course, trigger another bull market for the gold mining stocks. But this will take some time and is tightly linked to the course of the USD in the future as well as the level of the interest rates and inflation. The demand for gold should be stable for some time but a pick-up is likely as early as 2016. In a strong rally occurring in such an environment, one may see the gold price hitting the 2.000 USD figure...