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Morningstar | Goldcorp Stumbles in 2Q; Full-Year 2018 Targets Now Look Challenging. See Updated Analyst Note from 26 Jul 2018

In the second quarter, Goldcorp produced 571,000 gold ounces, down 10% from the prior-year quarter. Surprisingly, this was even a step back from the first quarter in which the company produced 590,000 ounces. Costs took an unfavorable turn as well, with all-in sustaining costs, or AISC, reaching $850 per ounce compared with $800 per ounce a year ago. As a result, despite a 3% higher gold price, lower production volumes and higher costs led to a 23% decline in adjusted EBITDA.

Yet, despite the tough second quarter, Goldcorp maintained its full-year guidance for 2.5 million gold ounces at AISC of $800 per ounce. The company would need to have a stellar second half to achieve these targets. However, given the production and cost challenges thus far, we think it is unlikely. We've lowered our near-term estimates as a result.

Nevertheless, we think the company's longer-term 20/20/20 growth plan remains achievable as the Penasquito pyrite project and Musselwhite materials handling project  developed on schedule. We're lowering our fair value estimates to USD 16.50 per share and CAD 21.50 per share, down from USD 17.50 and 22.50, respectively. Our no-moat rating is unchanged.

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."