Widening margins the story for gold producers in Q3

As gold bugs will gladly point out, the price of the yellow metal has been one of the strongest performers during the market volatility of the past few months.

Gold equities, on the other hand, have largely underwhelmed as share prices have lagged far behind the rapid ascent of physical gold as investors have shied away from equity markets.

But with gold producers set to report their next round of earnings in the coming days and weeks, that trend might finally be changing.

“In the third quarter and to date in the fourth a number of Tier 1 and Tier 2 gold stocks with positive fundamentals have outperformed the gold price and we believe this trend should continue given the significant margins and potential to return capital to investors,” Stephen Walker, analyst with RBC Capital Markets, said in a note to clients.

Companies with the potential to surprise to the upside include Alacer, Barrick, Dundee Precious Metals, Franco Nevada, Goldcorp, Kinross, Newgold and Royal Gold.

“As margins continue to increase we expect dividend increases and the potential for share buybacks to be announced,” he said. “We believe gold producers need dividend yields above 2% to attract fundamental investors and provide an incentive over physical gold.”

There are a couple of compelling reasons why profit margins are likely on the rise.

Gold prices averaged US$1,706 an ounce in the third quarter, up 13% compared with US$1,509/oz in the second.

The currencies of gold-producing countries, such as Canada and Australia, all depreciated against the U.S. dollar in the quarter, which should have a positive impact on costs.

As well, oil prices fell 12% but the effects were largely cancelled out by wage inflation, with the net average cash input costs for gold producers expected to be around US$580/oz compared with US$576/oz the quarter before.

“If the global economy remains sluggish, we could see cash costs begin to ease or at least remain stable in the fourth quarter and into 2012,” he said.

Overall, North American producer margins are expected to rise to US$1,126/oz compared with US$933/oz in the second quarter.

“Strong second-quarter operating results were overshadowed by capital costs increases at several projects, however we believe the worst of this is now behind us and expect record margins to be the key theme in the third quarter,” Mr. Walker said.

Allied Nevada, Claude, Iamgold, Jaguar, Lake Shore, Newmont and Osisko, on the other hand, have downside potential.