Why Gold Miners Are Not Glittering

Last week, gold traded above $1,000 per ounce for the first time in 11 months. Though the precious metal has pulled back over the past few days, it was still commanding $965 an ounce this morning. (Last November, prices nearly fell below $700 per ounce.)

The rally in gold prices has not gone unnoticed. Last week, NPR's Marketplace did a story about how people are holding gold parties. These quasi-social events pay participants for their old jewelry and other related items.

Given the economic backdrop, it's not surprising that gold has risen. The financial system is in crisis, stocks are volatile, treasuries are in a bubble and other commodities have plunged.

What is notable about the rally in gold prices, however, is that the higher price is not translating into improved profit forecasts for the gold miners. In fact, quite the opposite has occurred with more full-year earnings estimates being cut than raised. Mining-Gold has a 4-week revisions ratio of 0.88 (37 estimates revised up and 42 estimates revised down).

Relative to the vast majority of other industry groups, this revisions ratio is actually good, but it certainly does not reflect surging gold prices.

Rally In Gold Is Not Sending Profit Forecasts Higher

The disparity could be reflective of the fact that brokerage analysts expect gold prices to drop. This is important since gold companies seek to maximize the spread between mining costs and selling prices. If the spread is projected to narrow throughout the remainder of the year, then the current rally in gold won't help profits significantly.

The price of other metals is having an adverse effect on mining profits. In its recent conference call, Agnico-Eagle Mines (AEM - Analyst Report) discussed how plunging zinc prices impacted their margins. For other companies, copper is a headwind.

Overall mining production is down, and it's possible that this is also influencing sentiment. Earnings estimates for companies that manufacture mining equipment have fallen dramatically over the past few months. Though there is not a direct correlation between gold company profits and demand for mining equipment, weakness in part of a sector can lower forecasts for other parts of the same sector.

Finally, the economy and global financial crisis are playing a role. Demand for jewelry has dropped globally. Emerging economies are struggling, which means citizens of those countries have less wealth to buy gold. And the tight debt markets make it difficult to obtain new funding for expansions.

Are Analysts Being Too Pessimistic?

Nonetheless, there is the possibility that brokerage analysts will be proven wrong. Throughout last year, brokerage analysts were behind the curve on projecting what price oil would command - both during the first-half rally and the second-half plunge. If investors remain fearful, more money could get allocated to gold.

Commodity prices are difficult to predict. Translating those volatile prices into profit forecasts is even more difficult.

It's worth noting that the brokerage analysts themselves are split on the profit outlook for some gold companies. For example, 3 analysts have raised and 5 analysts have cut profit forecasts on AEM over the past month. A similar split exists on Barrick Gold Corporation (ABX - Analyst Report) and IAMGOLD Corporation (IAG - Snapshot Report), with 2 analysts raising forecasts and 3 cutting.

Complicating matters is the fact that many analysts have not changed their forecasts. Out of the 16 covering Goldcorp Inc. (GG - Snapshot Report), nearly half have not adjusted their projections during the past 4 weeks (8 have raised and 1 has cut). A similar situation exists for Eldorado Gold Corporation (EGO - Snapshot Report), with just 7 of the 13 analysts making recent changes (3 raised and 4 cut).

Related ETFs

Investors should be aware that most gold companies are small in size. In the market capitalization of the entire Mining-Gold group barely exceeds the value of Google Inc. (GOOG - Analyst Report). An alternative method of trading the gold miners, either long or short, would be to use the Market Vectors TR Gold Miners (GDX). This is a weighted ETF that invests in gold mining companies with market capitalization greater than $100 million and average daily volume in excess of 50,000 shares.

Investing In Gold

Another alternative is to invest directly in gold or combine gold-related securities with mining stocks. Our partners, Casey Research, are experts in gold and all things-gold related. I encourage you to look at their advisory service, Big Gold.

Zacks Premium and Zacks Elite subscribers can view the Zacks Industry Rank List at http://www.zacks.com/zrank/zrank_inds.php. This interactive list allows you to see all of the companies, and their Zacks Rank, within more than 200 industries. Shown below is the Zacks Sector Rank List, which shows the trend in estimate revisions on a broader scale.

Charles Rotblut, CFA, is the senior market analyst for Zacks.com. He can be reached at crotblut@zacks.com.

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