Gold ended the year at $1182/oz which means its closing price is now down two years in a row. This has obviously caused a lot of mining companies trying to adjust to ‘the new reality’ by slashing costs but unfortunately the market hasn’t really taken these steps into consideration yet as both the GDX and GDXJ ETF’s have been continuously decreasing as well and ended the year just above their bottoms as you can see in the next charts.
[6]Even though the RSI (Relative Strength Index) of both ETF’s isn’t indicating an oversold situation, we at Sprout Money are quite optimistic about the start of 2015 – that is, if gold doesn’t continue its slide. We would like to point out two specific factors which could (and should) contribute to a better than expected operating and financial performance of gold mining companies.
First of all, even though the RSI isn’t that low anymore, the trend in the Money Flow Index (MFI) is quite positive and seems to have bounced on what could be considered to be the bottom line. The MFI is a useful metric as it shows the buying and selling pressure in certain equities and in the final few days of 2014 here definitely was some upward pressure which started even before the end of the tax loss selling. That’s an encouraging sign, and we will be looking forward to see if this trend continues into the new year.
But that specific technical indicator isn’t the only reason why we are cautiously optimistic about a good start of 2015 for gold mining equities. One of the major complaints in 2014 was that a strengthening dollar was really bad news for the gold price. That’s true, but the positive takeaway of this currency appreciation is conveniently being ignored. A stronger dollar with a relatively stable gold price is a blessing for gold mining companies which are operating outside the USA.
Let’s for instance have a look at Canada, which is a major producer of gold. Companies operating in Canada generate their revenues in US Dollar by selling the gold on the world market, but do incur the majority (not all) of their expenses in Canadian Dollar. Let’s move away from the theory and look at some hard numbers. In early October, the gold price in USD was $1215 and it lost 2.7% in three months time to close at $1183.
However, the USD/CAD exchange rate made an opposite move. Trading at 1.116 as of at the end of September, the exchange rate closed at 1.162 on December 31st which is a 4.1% move. This means that despite the lower gold price in USD, the revenues for companies operating in Canada increased faster exactly because of the weaker dollar.
Okay, we agree a 1.4% difference isn’t extremely exciting, but let’s have a look at the Brazilian situation which is also an important commodity producer. Remember the gold price lost just 2.7% in three months time, but have a look at the USD/BRL chart:
[8] [8]Indeed, the Brazilian Real has lost 8.6% in the exact same three months. This means that producers operating in Brazil saw their operating margin increase by roughly 3% if the costs in the local currency counted for half of the total production costs. 3% is a conservative estimate as for instance the fuel price also will have a big impact, even on gold mines which were connected to the power grid. A lower fuel price means it will be a lot cheaper to keep the mining fleet going and as we explained in a previous column [9], the effects of cheaper fuel should not be underestimated for an energy-intensive sector like the mining sector.
So despite a very bad final quarter in 2014 there’s hope for the mining sector and currency fluctuations and the level of fuel use will be very important in 2015 and is something you should keep in mind when selecting your gold mining investments this year as we are convinced these kind of details will be important to be able to outperform the market.
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