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Declining gold stocks
May 2, 2005

If you own gold stocks and follow the gold market at all, then you are aware that the stocks declined by almost twenty percent since the middle of March, while the gold price itself has remained relatively unchanged. Why?

One possibility is that investors anticipate a decline in the gold price. Gold stocks don’t always correctly indicate coming changes in the gold price, but they are right more often than they are wrong.

Another possibility is that gold stocks have simply declined along with all the other stocks: the Dow Jones Industrial Average is down nine percent since the beginning of March.

Yet another possibility is that gold stocks are down because investors are disillusioned by the earnings from the sector. Take Newmont, the largest gold mining company in the world, as an example: it had marginally lower first quarter earnings than last year, despite a ten percent rise in the dollar gold price. Why own gold stocks if a ten percent increase in the gold price does nothing to their earnings? Given the leverage that gold mining stocks should have to the gold price, a ten percent increase should result in a substantial increase in earnings.

The reason why many gold mining companies are hardly making any more money now than they were a year ago is that the gold price has been rising in US dollars because the US dollar has been falling on foreign currency markets. That means if a company is mining gold outside the United States (and not in any area where the US dollar is the de facto currency), it may not have had any benefit from the rise in the US dollar gold price. The gold price in many other currencies has not risen at all.

Having said that, let me add that I don’t know of any gold mining companies with projects exclusively in the US that are worth owning. I own a few gold exploration companies working in Alaska and Nevada, but no gold producers. The problem is that the big names, like Newmont, Barrick and Placer Dome, are so geographically diversified that they cannot be called US gold mining companies. They may be listed on US stock exchanges, but because their operations are scattered all over the world, the increase in the US dollar gold price has had a marginal, if any, impact on their bottom line earnings.

Does this mean that gold stocks will continue to under-whelm us when the US dollar gold price strengthens?

If the market were rational the answer would be yes. Only the stock of those gold mining companies that have direct leverage to the falling US dollar (in other words, gold mines in the US) should see their share prices increase as the dollar falls.

However, a falling dollar not only means more dollar revenue for gold production, it will ultimately also lead to higher production costs. But the operating margins of gold mining companies with direct leverage to the falling US dollar should continue to expand for two reasons. Firstly, assuming the mine is cash flow positive, the increase in cost is on a lower base than the increase in revenues. Say the production cost is $300 an ounce and the gold price is $400 an ounce. The operating margin is therefore $100 an ounce. A ten percent increase in both revenue and cost would also result in a ten percent increase in operating margin: 440 – 330 = 110. Secondly, the increase in revenue from a decline in the dollar is instantaneous while the increase in costs will come more gradually. Therefore, as long as the dollar falls faster than the rate of inflation (the most likely scenario) the operating margins of a US based gold mining company should increase much more rapidly than the example above.

But the market is not rational. Most investors still look at the US dollar gold price as “the” gold price and when gold increases in US dollars they buy gold stocks almost indiscriminately. Once enough investors figure out that an increase in the US dollar gold price does not necessarily benefit all gold mining companies, then the gold stocks as a sector could very well under-perform the US dollar gold price.

Is this already happening? I do not think enough investors are paying attention to the geographical location of mining operations and the impact of currency exchange rates yet. So I suspect that the lackluster performance of gold stocks at the moment has more to do with the general malaise in the market.

We are at a precarious point in the economy and the financial markets. I have written much about where I think the dollar, the gold price and the economy is going. I don’t see anything to change that view. Rather, I see current events as confirming that we are on track to see a major decline in US economic growth, further weakening of the dollar and, as a result, much higher US dollar gold prices.


Paul van Eeden


Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website ( or contact his publisher at (800) 528-0559 or (602) 252-4477.


This letter/article is not intended to meet your specific individual investment needs and it is not tailored to your personal financial situation. Nothing contained herein constitutes, is intended, or deemed to be -- either implied or otherwise -- investment advice. This letter/article reflects the personal views and opinions of Paul van Eeden and that is all it purports to be. While the information herein is believed to be accurate and reliable it is not guaranteed or implied to be so. The information herein may not be complete or correct; it is provided in good faith but without any legal responsibility or obligation to provide future updates. Neither Paul van Eeden, nor anyone else, accepts any responsibility, or assumes any liability, whatsoever, for any direct, indirect or consequential loss arising from the use of the information in this letter/article. The information contained herein is subject to change without notice, may become outdated and will not be updated. Paul van Eeden, entities that he controls, family, friends, employees, associates, and others may have positions in securities mentioned, or discussed, in this letter/article. While every attempt is made to avoid conflicts of interest, such conflicts do arise from time to time. Whenever a conflict of interest arises, every attempt is made to resolve such conflict in the best possible interest of all parties, but you should not assume that your interest would be placed ahead of anyone else’s interest in the event of a conflict of interest. No part of this letter/article may be reproduced, copied, emailed, faxed, or distributed (in any form) without the express written permission of Paul van Eeden. Everything contained herein is subject to international copyright protection.

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