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Morningstar | Eldorado Sees Mixed Results in 3Q, as Production Exceeds Expectations but Costs Rise

Eldorado’s third quarter provided mixed results. On one hand, gold production rose 21% to 84,783 ounces. On the other hand, all-in sustaining costs, or AISC, rose 20% to $1,112 per ounce. Consistent with the third-quarter results, Eldorado raised its full-year production guidance to 345,000 to 355,000 ounces, up from 330,000 to 340,000 ounces revised during the second-quarter earnings release. However, management also increased cash operating cost guidance to $600 to $650 per ounce, up from $580 to $630 per ounce.

The updates to our near-term forecast weren’t enough to drive a change in our U.S. dollar-denominated fair value estimate of $2 per share. Slight changes to the currency exchange rate lead us to increase our Canadian dollar-denominated fair value estimate to CAD 2.60 per share from CAD 2.50 for no-moat Eldorado Gold. Uncertainty surrounding the opening of Greek projects remains the biggest outstanding issue, and unfortunately, the company continues to work toward a resolution without an update. Although improvement projects at Kisladag and the opening of Lamarque provide some growth, we think Greece is still the biggest uncertainty on Eldorado’s share price.

Although shares currently trade at roughly 60% 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 September 2018, the U.S. Federal Reserve once again raised the federal-funds rate by 25 basis points to 2.25% from 2%. This was the third rate hike of the year. Most central bank officials expect one additional rate hike in 2018 and three in 2019. The market appears to be largely in line with this view, as current interest-rate option prices imply a more than 70% chance that there will be at least one more hike by the end of 2018.

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 proven true, as ETFs have seen net outflows since June through September.

On the back of weak investment demand, gold prices have fallen to nearly $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.