The major gold miners are betting on rising gold prices to
continue funding new projects and exploration by maintaining production plans
and only marginally reducing capital expenditures.
Four major gold mining companies recently reported their Q2
results and outlined plans for the rest of 2013. Barrick, Newmont, GoldCorp, and Yamana are
all maintaining guidance for full year 2013 production volume. A couple of them slightly lowered guidance
for All In Sustaining Cash Cost (AISC) per ounce, despite forecasting lower
prices for by-products, such as silver, copper, lead, and zinc. In order to preserve some cash the majors are
slightly reducing capital spending for projects and cutting exploration and administrative expenses.
Free Cash Flow is
Hugely Negative for the Majors
They have been spending much more on new projects and
exploration than their operations bring in.
Free Cash Flow is Net Cash Flow from Operations less Capital
Expenditures. It is equivalent to the
cash that is available to pay interest and dividends and to reinvest in the
business. In the short term, negative
free cash flow is not necessarily a bad thing assuming the capital is invested
wisely and financing is available. Most
growing businesses have negative free cash flow as they invest in inventory, accounts
receivable, and equipment to support growth.
Cash and Credit Can
Finance Cash Outflows for Now. If
Necessary, Majors Can Reduce Production and Focus on High Grade Deposits to
Generate Cash.
These majors have cash on hand and credit facilities in
place to finance their cash flow needs for at least several quarters. If gold prices were to stay below $1,300 for
long, the miners would begin preserving cash by cutting more project and
exploration capital and ceasing production at higher cost mines. For example Barrick has a total All In
Sustaining Cash Cost (AISC) of $938 per ounce.
Yet over 25% of Barrick’s production is from mines with and AISC over
$1,000.
AISC is an industry metric that miners began voluntarily
reporting in 2013. The intent is to
quantify the cash cost of current gold production. AISC includes sustaining capital expenditures and excludes any cost of
development and exploration that would materially increase production. In theory, a miner can generate cash if sales
are above the AISC. However, mines would
be quickly depleted if the miner did not have profit beyond the AISC to invest in development. By definition AISC also
includes the benefit of by-product sales.
Therefore if gold prices continue to decline, AISC will increase if silver
and copper prices are dragged down in concert.
The four major gold miners presented below are forecasting
AISC to be $1,016 per ounce for 2013. Barrick
presented that the entire industry has a higher AISC of about $1,200. The industry average is pushed up by higher
cost South African mines. You may wonder
how an industry that was presumably profitable 8-10 years ago when gold was
$350/ounce can now have costs of $1,200/ounce.
Gold mining cost has increased dramatically due to declining ore grades and
inflation. Refer to my previous post for
more about the historical cost structure http://rikgreeninvestorforum.blogspot.com/2013/08/gold-has-become-more-precious-mining.html
Worldwide gold production, excluding China and Russia has
been flat for many years and is expected to continue with little or no growth. Production will fall 15%-25% if gold prices are
below $1,300 for many quarters as higher cost mines are shut down. In an efficient market lower production in
response to lower prices would create a floor for long term prices. However, these are extraordinary times in the
precious metals markets. Note that
GoldCorp and Yamana are exceptional in the industry because they are achieving
production growth in 2013 and beyond.
The majors are betting that gold prices rebound so that
their businesses generate cash while continuing to invest in significant
capital projects. Otherwise they would
be cutting more capital spending and revising production volume targets. They know that debt financing is a dangerous
strategy.
Q2 Average Gold Sales
Price was over $1,350 per ounce
The financial results in Q2 were ugly even after adjusting
for write-offs and restructuring charges. During Q2 the miners sold their production at
an average price above $1,350. Their
results would have been even worse if gold had been $1,300 per ounce all
quarter.
No Hedging of Gold
Sales
All four of these major gold miners did not mention plans to
start hedging sales of gold. Several
specifically state in their Q2 earnings reports that they do no hedge
sales. There has been talk in the gold
markets that a recent increase in the number of short gold forward contracts is
due to miners starting to hedge. These
four are not contributing. Hopefully,
they learned their lesson after Barrick paid $5.2B in 2009 to settle gold sales
contracts.
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