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Morningstar | Eldorado Gold Reports Decent 2Q and Raises Guidance, but Greek Uncertainty Remains

Eldorado’s second quarter looked much better than the year prior, with gold production rising 56% to 99,105 ounces. All-in sustaining costs, or AISC, rose 10% to $934 per ounce. However, production more than offset the increased costs as gross profit from gold mining rose 7% to $30 million. As a result of solid first-half progress and revisions to Kisladag’s outlook, the company raised full-year guidance to 330,000 to 340,000 ounces, up from 290,000 to 330,000 ounces.

The updates to our forecast weren’t enough to change our fair value estimate, so it remains unchanged at $2 per share and CAD 2.50 per share for no-moat Eldorado Gold. Uncertainty surrounding the opening of Greek projects remains the biggest outstanding issue for Greece, and unfortunately, the company had no update at this time. Although improvement projects at Kisladag and the opening of Lamarque provide some growth, we think Greece is still the biggest uncertainty weighing on Eldorado’s share price.

Although shares currently trade at more than a 45% discount to our fair value estimate, we reiterate our extreme uncertainty rating. Given that Greece has such a large impact on the company’s value and the issue remains highly uncertain, the difference in valuation outcomes is massive and warrants caution from potential investors.

In June 2018, the U.S. Federal Reserve once again raised the federal-funds rate by 25 basis points to a range of 1.75% to 2%. This was the second rate hike of the year. Most officials at the central bank expect two additional rate hikes in 2018. The market appears to be largely in line with this view, as current interest rate options prices imply a more than 66% chance that there will be at least two hikes for the full year.

All else equal, the prospect of higher inflation adds to gold's investment appeal, which is one reason ETF gold holdings rose through most of 2018 and spot prices remained above $1,300. However, as we had anticipated, higher inflation has emboldened the Fed to pursue rate hikes at a quicker pace, which lifts the real interest rate and, in doing so, increases the opportunity cost of holding gold.

Historically, we've observed a strong inverse relationship between the real interest rate and the price of gold: when the former rises, the latter tends to fall. We thought it was only a matter of time before gold investment adjusts to the higher opportunity cost, not only leading to slowing investment demand, but also outflow of gold from ETFs back into the gold market. Our prediction has begun to take hold as ETFs saw outflows in all regions in June.

On the back of weak investment demand, gold prices have fallen to slightly above $1,200 per ounce. Nevertheless, we still believe gold has a promising future, and we forecast a nominal gold price of $1,300 per ounce by 2020. We expect that, in the long term, Chinese and Indian jewelry demand will fill the gap left by waning investor demand.

For more on why rate hikes present a significant risk to near-term gold prices, please see our August 2017 report "Gold is Standing on One Leg."