What a difference 7 months can make for the gold and silver industry. In early January, precious metals were unloved and showing no signs of snapping their multi-year bear market. Very few believed they still provided valuable diversification within a portfolio. At the time, the gold price was hovering around $1,050 an ounce and some companies were mining gold at a loss.
Back in June 2013, the World Gold Council introduced a measure called “all-in sustaining cost” (AISC for short) to provide a standardized metric to calculate the overall costs of producing gold. AISC captures cash costs, corporate costs, reclamation and sustaining capital expenditure. This new metric was intended to provide investors with greater transparency and more common measurement for all companies.
In the second quarter of 2013, AISC peaked for the industry at $1,151 per ounce – at this time gold was trading for about $1,400 per ounce, so the net margin amounted to approximately $250 per ounce for the industry. Keep in mind that within the industry there are low and high cost producers – so the individual companies vary.
In January 2016, with a gold price of $1,050, the average producer margin slumped to $220 per ounce. Despite the 25% decline in the gold price since 2013, profit margins only fell by 12% as the industry responded by cutting costs and restructuring their operations. They were also assisted by lower fuel costs and some companies were helped with weaker local currencies versus the US dollar.
With gold now trading at $1,350 per ounce and AISC holding steady, net profit margins for the industry have increased from $220 to over $500 per ounce – an increase of 127% in just 7 months. The industry hasn’t enjoyed similar profit margins since 2012, when the price of gold exceeded $1,600 per ounce.
During the first 7 months of 2016, the Sprott Gold Miners ETF (NYSE Arca: SGDM) increased by 126.34%. Past performance does not guarantee future results.
While there isn’t a perfect correlation between profit margin growth and stock appreciation, you can clearly see there is a strong link. So while the year-to-date stock gains for gold stocks look astronomical, they really reflect the significant improvement in profit margins that the industry could benefit from.
Are the recent gains in the gold mining stocks sustainable? If the price of gold holds at current levels, then we believe that current valuations will hold. No doubt, the sector is volatile but the macro drivers supporting gold right now are powerful.
We have never witnessed a period where trillions of dollars of government bonds have negative yields and interest rates for some countries stand at their lowest levels in centuries. In this unprecedented investment environment, gold has become a compelling alternative currency and store of value. If gold prices continue to move higher, we anticipate the gold miners to benefit on an exponential basis.
Courtesy: Sprott US Media
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