Barrick Prepares For Sluggishness In Gold Prices As Fed Raises Interest Rates

The Federal Reserve announced a 25 basis point increase in the target range for the federal funds rate last week, a step that was widely expected. ^[1] Though the rate hike was expected, it is indicative of the Fed’s belief in the sustainability of the economic recovery in the U.S., which has important implications for the trajectory of gold prices. Improving economic conditions dampen the investment demand for gold, which is largely considered a safe haven asset from an investment point of view.

With the decline in gold prices over the past couple of years, gold miners have been striving to reduce their operating costs and some have even sold off high-cost mines in response to the decline in prices. Just last week, Barrick Gold Corporation (NYSE:ABX) announced the sale of its interests in the high-cost Spring Valley and Ruby Hill mines, both located in Nevada. ^[2] Considering that gold prices are unlikely to rise significantly in the near term, it was a good move.

Gold Prices

With strengthening economic conditions and increasing interest rates, equities and interest-bearing securities become more attractive avenues for investment vis-a-vis gold. The following chart illustrates the trajectory of gold prices so far this year, with the declines in the latter part of the year primarily due to expectations of an interest rate hike by the Fed.

Gold Prices in 2015, Source: Kitco

Since gold offers no returns besides capital gains, rising interest rates tend to shift investors away from gold. Last week’s interest rate hike had largely been factored into market expectations, with the announcement not making a significant impact on gold prices. However, depending on a number of macroeconomic indicators such as inflation, economic growth, and the unemployment rate, the Fed could further raise interest rates in 2016. ^[3] Further tightening of interest rates will negatively impact investor appetite for gold.

Apart from the investment demand for gold, slowing economic growth in China, the world’s largest consumer of gold, is likely to retard the growth in jewelry demand for the metal. Jewelry demand for gold has a direct correlation with economic growth and weakening Chinese economic growth does not bode well for global gold jewelry demand in the near term. As the jewelry and the investment demands for gold taken together account for nearly three-fourths of the overall demand for the metal, gold prices are unlikely to appreciate significantly in the near term.

Gold miners have factored in a period of sluggish growth in gold prices into their plans, with companies such as Barrick Gold having successfully reduced their operating costs through a combination of cost reduction initiatives and the sale of high-cost mines. Barrick Gold’s  management reported during its Q3 conference call that measures undertaken by the company would enable it to generate positive free cash flows at gold prices of $1,100 per ounce. ^[4] The sales of the mines concluded last week could lower this threshold. Thus, Barrick Gold is certainly preparing itself for weakness in gold prices in the near term. With prices unlikely to rise significantly in the near term, these measures will certainly stand the company in good stead.

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1. Press Release, Federal Reserve [↩]
2. Barrick Completes Sale of Non-Core Assets in Nevada to Waterton, Barrick Gold News Release [↩]
3. Fed Raises Rates After Seven Years Near Zero, Expects ‘Gradual’ Tightening Path, Wall Street Journal [↩]
4. Barrick Gold’s Q3 2015 Earnings Call Transcript, Seeking Alpha [↩]