It is no secret that the past 12 months have been a tumultuous period for gold. Price per ounce has plummeted from just shy of $1800 in October of 2012 to below $1400 as of June 2013. There exists no shortage of analysts calling for this trend to continue, many offering up compelling arguments as to why gold might fall, and remain, below $1000/oz.
Of course there are also those that view the current price and any possible further dip as unsustainable with their reasoning rooted in the simplest of economic concepts, supply and demand, and if they are to be believed then this might offer up an opportunity for investors.
In a nutshell, it all boils down to production costs. For a long time mining companies have listed their production costs as a 'cash cost' figure, which simply refers to the cost of mining in relation to the total amount of ounces of gold produced. While offering some insight into what is being spent per ounce there are a number of additional costs that must be maintained to ensure a mine's sustainability of operation, sustainability being key when considering investment. To improve the quality of their reporting figures some mining companies are now releasing what is being referred to as 'all-in sustainable cash cost' which offers a much more transparent view of the real cost per ounce for the mine it represents. The new figure includes things like administration costs, sustaining capital expenditures and perhaps most importantly, the cost of development and exploration. In an industry such as this development and exploration are key to a company's future operations, or in other words, sustainability.
The all-in sustainable cash cost is of course much higher than its simpler cash cost predecessor, and therein lies the problem for producers.
Thomson Reuters GFMS reported in their 2013 gold survey that the average all in sustainable cash cost for mining companies was $1211 per ounce. When prices were at an all-time high circa September '11 this offered up a healthy profit, but as price has fallen this profit has decayed and at current prices sits at less than $200 per ounce.
To illustrate why this profit contraction represents an opportunity for investors, and before looking at individual mines, it is important to consider the possible future price of gold, and the effect this will have on overall production.
Day one, semester one of an economics undergraduate course deals with the concept of supply and demand. The price of an asset will rise as demand for that asset increases and/or supply of that asset constricts and vice versa. While not the point of this article, some argue that the price decline seen over the last six months is a direct result of increased production (under the allure of inflated profits at high sale cost). Whatever the macroeconomic reasoning behind the 'crash' there can be no argument as to the effect it will have on production. Those companies who run at high production cost (relative to the rest of the industry) will be unable to meet day to day operational costs with decreased revenue. Many of these will have to cease production, or at very least expansion, which will inevitably lead to an aggregate fall in supply. This supply contraction will lead to those seeking gold having to pay inflated prices to those who already own it, which will drive prices back up.
The same reasoning undermines the aforementioned analyst speculation that price per ounce will fall and remain below $1000. With the production cost sitting at nearly $200 more, it would only be a matter of time before the price has to rise or the industry goes bust (in which case price would rise anyway).
Macroeconomic prediction is fair and well, but without specific investment vehicles it is relatively useless to the investor. More pertinent would be a look at some mines currently in production, their all in sustainable costs and an idea of whether or not they would be able to survive and expand if the price of gold did continue to fall before its inevitable rise. So here you go.
The table below shows a number of Nevada based mines, alongside some production stats and financial information. I have chosen Nevada as an area of focus for two mainly risk related reasons. The first of these reasons being that Nevada is both historically and presently the largest contributor towards US gold production. This reduces the risk associated with investing in so called junior and more exploratory mining companies. The second reason being that as it stands the US has the lowest cash cost of production in the world. With the sale price of gold being set at a global standard it stands to reason that those nations with the highest production costs will be hit hardest by a sale price decrease.
A selection of Nevada mines
|Name||Owner||Type||Resource size||Processing type||Cash cost||All-in Cash cost|
|Rochester||CDE||Open Pit||308,000 oz. (est.)||Oxide heap-leach||$505||$1058|
|Cortez||ABX||Carlin||15.1m oz. (est.)||Heap leach, Cyanidation and CIL||$177||$1050*|
|Goldstrike||ABX||Carlin||1.24m oz. (est.)||Autoclave circuit||$605||$1050*|
|Sleeper||PZG||Vein type||2.6m oz. (est.)||Oxide Heap leach||$767||$996|
|Pan||MDW||Carlin||579,000 oz (est.)||Open pit, Heap leach||$585||$824|
|Relief Canyon||Pershing||Open Pit||564,000 oz. (est.)||Oxide heap-leach||Un- stated||$800|
*North American operations avg.
With reference to the table, the size and resulting importance of Barrick Gold as an indicator of benchmark cost in the industry makes it a good place to start. ABX controls and operates mines all over the world and owns two of the most prominent gold mines in the US, Goldstrike and Cortez. Through Q1 2013 these mines produced 0.23 million and 0.34 million ounces of gold, respectively. Full year production in its North American operations is expected to be around 3.6 million ounces. In its latest reporting (Q1 2013) Barrick states that during 2013 they will operate with an all in sustaining cost of $950-$1050 per ounce, revised downwards from previous guidance. While the revision downwards makes ABX slightly more attractive, if gold remains at its current level or falls even further there will be very little if anything in it for investors. ABX stock does have its advantages, however. Such a high degree of incumbency in the industry makes it a relatively safe play for those looking to take a position with relatively little risk.
Similar in stature to Barrick is Newmont (NEM). Newmont controls a considerable number of operating mines in Nevada, a number of which run along the bountiful Carlin trend. As with the majority of other mining stocks, Newmont's share price has fallen in line with the decline in gold prices, from a peak of around 70 in November '11 to just above 30 as of June '13. There are two ways to look at this, the first being that as per Newmont's claim to have all in sustaining cash costs of around $1086 per Au ounce they could be running at a loss in gold production if prices fall much lower, which could cause their share price to take a further hit. The second is that being an incumbent operator in the industry such an event could be weathered, and with a shake-up that removes a lot of the smaller competition, consolidated by the resulting supply constriction that drives up prices 30 could be considered cheap.
Looking long these industry behemoths might present an opportunity to buy into what could prove to be a bottoming out of gold price-driven share decline without exposing yourself to an excessive amount of risk. But what about looking at things from an all in sustainable cash perspective, irrespective of size or capitalisation?
The key to weathering the current storm in the gold mining industry seems like it might be production costs. Being able to operate at, and maintain low all in sustainable cash production costs will inevitably separate those who will survive from those who won't if gold prices do take a further dive and there are a couple of forerunners in this regard.
The first, and perhaps most interesting, is junior mining company, Pershing Gold (PGLC). Headed up by Stephen Alfers, the former chief of US operations at mining giant Franco Nevada (FNV), Pershing owns Relief Canyon, a supposed prime slice of land that not only borders real estate owned by Newmont but also lies just a few miles away from Coeur D'Alene's Rochester silver mine. Production is set to commence by 2014, which could be prime time to take advantage of a turnaround in gold pricing, and they claim to be able to run at an all in sustainable cash cost of $800 per Au ounce. Such low production costs put Pershing in a position to take profit from an industry in which others will likely struggle, even if gold prices continue to fall. With relatively low capital expenditure required to meet the upfront cost of production (around $30 million) and a market capitalisation of $107 million (at the time of writing) Pershing might look like an attractive opportunity to the bullish investor.
Another junior miner that is attracting attention is Midway Gold Corp (MDW). Midway is in a similar position to Pershing in that it is looking to get up and running with a couple of major projects also located in Nevada. The first and most advanced in terms of production schedule is Pan, located in White Pine County. Pan is referred to as Carlin style, the reference being a deeply resource rich flurry of mining operations owned by Newmont Gold in Eureka. Construction for the Pan project is due to commence this year with production set to start in 2014. Midway expects to be able to produce at an all in sustainable cost of $824 per ounce.
The second Midway interest is the Gold Rock project. 8km south of the Pan project Gold Rock is set to start production in 2016, with an estimated 310,000 oz. of indicated gold and a further 331,000 oz. of inferred gold. Again referred to as Carlin style, this project does not have an all in sustainable cost assigned to it yet but if Midway can achieve anywhere near the $824 suggested for Pan (which given the similarities between the two mines is not unrealistic) then this project could further strengthen Midway's bid to take advantage of a possible turnaround in gold prices over the coming years.
Finally, another junior operating out of Nevada that might warrant some consideration is Paramount Gold and Silver (PZG). Its 100% owned project mine, Sleeper, has just turned in exceptional test results for both gold and silver grades, and is expected to have all in sustained cash costs of $996 per ounce. While not as low as the aforementioned these costs are considerably lower than some of the incumbent projected costs and alongside 100% ownership could represent an opportunity for the more risk attuned investor.
So with all this information in mind, what are we likely to see as time progresses? One thing is for sure, that mining and exploration will not grind to a halt. Irrespective of the price of gold there will always exist market mechanics that will act as an equilibrium imposing force. Prices will fall, and rise, and fall again. How quickly these cycles occur however, and the severity with which they present themselves, will play a part in the inevitable shake-up of the gold mining industry that we are likely to see in the near future. Those companies which fail to react to falling prices by reducing operating costs will be forced to produce at less than cost, a luxury which very few can afford. Further to this, those who cut expenditure in the wrong places might suffer in the medium term; to remain sustainable some form of exploration and new discovery must continue.
On the other hand, for investors this presents something of an opportunity. With the inevitable influence of supply and demand bound to play a hand in gold's return, the right pick might just see an informed bullish outlook pay off.