Tuesday, August 13, 2013

Major Gold Miners Planning on Higher Gold Prices

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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