Mining’s old guard needs strong medicine
A new report details subpar investor returns in the mining industry over the last decade, particularly big cap diversified companies which have not adapted to new realities.
In early July 2014, Mark Bristow Randgold Resources CEO, said the gold mining industry was fundamentally broke at a gold price of US$1,300.00/oz.
“Gold has special properties that no other currency, with the possible exception of silver, can claim. For more than two millennia, gold has had virtually unquestioned acceptance as payment. It has never required the credit guarantee of a third party. No questions are raised when gold or direct claims to gold are offered in payment of an obligation; it was the only form of payment, for example, that exporters to Germany would accept as World War II was drawing to a close. Today, the acceptance of fiat money — currency not backed by an asset of intrinsic value — rests on the credit guarantee of sovereign nations endowed with effective taxing power, a guarantee that in crisis conditions has not always matched the universal acceptability of gold.
If the dollar or any other fiat currency were universally acceptable at all times, central banks would see no need to hold any gold. The fact that they do indicates that such currencies are not a universal substitute. Of the 30 advanced countries that report to the International Monetary Fund, only four hold no gold as part of their reserve balances.” Golden Rule, Alan Greenspan
The number one rule of investing is ‘always buy an asset that is priced below its replacement value.’ The cheaper you can pick up quality assets, knowing the price HAS to rise, the better.
Let’s see if gold is priced below replacement value.
In 2012, the World Gold Council (WGC), and senior gold producers, come up with a new production cost reporting measure. The new industry standard is now ‘all-in sustaining costs’ or AISC.
AISC was widely adapted by the sector in 2013. AISC includes sustaining capital (as grades decline and mines get older sustaining capital costs rise) as well as general and administrative (G&A) expenses.
AISC does not include costs such as project capital, dividends, working capital, taxes, financing and interest charges on debt, costs related to business combinations, asset acquisitions and asset disposals and items needed to normalize earnings (ie. stock options, charges for discontinued operations).
Let’s take a quick look at Newmont Mining Corp., a company that is primarily a gold producer.
Newmont Mining’s full year AISC guidance for 2014 is US$1,020 to $1080/oz. With today’s gold price of US$1223.00/oz and using a median price of $1,050/oz Newmont seemingly has a nice margin of US$173.00/oz.
But…
With US$350 billion in interest payments and US$200 billion in dividends each of the 5,000,000 ozs of gold Newmont is suppose to produce in 2014 gets $110.00 added to its $1,050.00 cost equaling $1,160.00/oz dropping Newmont’s margin to just $63.00.
Newmont is very close to being in the red even before many hundreds of millions of dollars have to be paid in taxes. And remember those other charges – project capital, working capital, costs related to business combinations, asset acquisitions, asset disposals and items needed to normalize earnings that are NOT included.
By taking a knowledgeable look at AISC reporting it’s easy to believe the gold mining industry, taken as a whole, is not generating free cash flow below US$1,300.00/oz.
Measures Taken
Attempting to get costs under control is having a hugely negative effect on the entire industry.
“As gold prices have decreased, miners have responded by cutting sustaining capex, research and development, and exploration costs. Let’s pay attention to how the industry is achieving these cost cuts, because it matters if they’re coming on the sustaining side.” Dave Milstead, How much does it really cost to mine an ounce of gold?, Globe & Mail
Gold miners have resorted to high grading – mining the higher grade ores while leaving behind the lower grade. Dundee reported miners under their coverage processed 8% higher grades in 1H14. This is unsustainable over the long term and means much higher gold prices in the future are needed to make a go of mining the lower grade.
As gold prices dropped miners have cut back on spending. Many mines are no longer profitable at today’s gold price and they are being put on care and maintenance. New projects are on hold or cancelled outright, exploration spending levels have fallen through the floor.
A junior resource companies place in the food chain is to acquire projects, make discoveries and hopefully advance them to the point where a miner takes it over. Discoveries won’t be made if juniors aren’t out in the bush looking at rocks.
According to the Engineering and Mining Journal (E&MJ) junior resource exploration budgets dropped 39% in 2013 and fell a further 29% in 2014.
“It seems inevitable that the mining industry’s response to 2013’s gold price crash will be detrimental to mine supply levels in future years.”Gold Survey 2014 Update, Thomson Reuters GFMS
According to Visual Capitalist the global average grade of producing mines is 1.18g/t. The world average grade of undeveloped deposits is 30% lower, coming in at .89g/t.
Asian Gold Buying
In 2013, China was officially crowned the world’s largest gold market accounting for around a third of global gold demand. Consumer demand soared 32 percent to 1,066 tonnes (up 160% from five years ago) of gold in the form of bars, coins and jewelry topping India’s 2010 record of 1,007 tonnes.
Gold production in China, over the last decade, has more than doubled as the country produced 6,827,000 ounces of gold in 2004. In 2014, gold production estimates are expected to be around 14.5 million ounces. The Chinese keep all of the gold they mine and the export of gold bullion is banned.
The following graph shows where Switzerland’s (Switzerland is a global hub for gold refining, with more than two-thirds of global gold transiting through the country) gold comes from and where it goes.
A great percentage of the West’s gold has hemorrhaged East and continues to do so. The top five countries getting mostly U.S & UK gold out of Switzerland are Hong Kong, China, India, Singapore and Saudi-Arabia. Asia accounted for 63 percent of total consumption of gold jewelry, bars and coins last year, up from 57 percent in 2010.
China is also importing massive volumes of gold from Hong Kong.
The Shanghai Gold Exchange reported 2014 total withdrawals came in at over 2,100 tonnes, just 3.6% off the 2013 record.
According to the World Gold Council Chinese gold demand will rise by roughly 25% over the next four years.
Per capita gold holdings in China are five grams compared to a developed nation 20 gram average. China’s gold reserves, at 1.2% of its total reserves, makes it the 5th largest gold holder by country – in comparison the U.S. and Germany hold 70%.
India has once again overtaken China as the world’s biggest gold consumer, buying 225.1 tonnes of gold jewellery, coins and bars Q3 2014, compared to 182.7 tonnes in China. India recently relaxed gold import restrictions scrapping the 80:20 rule that stated that 20% of imported gold had to be re-exported in fabricated form.
Central banks were net buyers of gold for the 15th straight quarter buying 93 tonnes during Q32014.
Leverage
Gold is, in this author’s opinion, an extremely undervalued financial instrument. A portion of every investors portfolio needs to be dedicated to holding gold and silver bullion.
But historically, and perhaps especially so today for all the reasons listed above, the greatest leverage to rising precious metal prices has been owning the shares of junior resource companies focused on acquiring, discovering and developing precious metal deposits.
“When the time comes and the gold price is moving to the upside again, you’ve got to be in the shares because that’s where the leverage is. This opportunity that’s been created – I don’t think I’ve ever seen, in the 40 plus years I’ve been following the sector, the shares cheaper in relation to the price of bullion as they are now. Given my extreme bullishness on where bullion is headed in the next three to four years, I think the opportunity in the shares is historic and I encourage people to take a very close look at them. What really encourages me is very few people own them today. They don’t even talk about it.” John Embry, I’ve never seen this in my 40+ years in the investment business, Mining.com
Conclusion
Do you want to own the cheapest gold and silver you can find to reap the maximum coming rewards? If you do, buy it while it’s still in the ground.
The fact is junior resource companies – the owners of the worlds future precious metal mines – are on sale. If you like their management team, their projects and their plans for 2015, perhaps now is the time to be slowly acquiring a position.
Why? Well besides the fact that I believe that precious metal focused junior resource companies offer the greatest leverage to increased demand and rising prices for precious metals there’s obviously going to be a very real and increasing trend for Mergers and Acquisitions (M&A). Juniors, not majors, own the worlds future mines and juniors are the ones most adept at finding these future mines. They already own, and find more of, what the world’s larger mining companies need to replace reserves and grow their asset base.
Gold’s bull market is not over and here at Ahead of the Herd our edge is twofold. First, it’s being right about the future for precious metals. Second, it’s having an excellent selection of well managed junior’s with plenty of metal in the ground to gain the desired leverage to rising gold and silver prices.
Precious metal focused junior companies are again going to have their turn under the investment spotlight and should be on every investors radar screen.
Richard lives with his family on a 160 acre ranch in northern British Columbia. He invests in the resource and biotechnology/pharmaceutical sectors and is the owner of Aheadoftheherd.com. His articles have been published on over 400 websites.
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