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Chris Bailey
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Award-winning global investor who resigned from his job managing a set of funds with over US$2bn under management so he could take full advantage of the current financial market opportunities. Likes to fuse bottom-up insights with top-down macroeconomic thought. Looks at all sectors and, with a... More
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  • Do A Couple Of North American Gold Heavyweights Stack Up? 0 comments
    Jul 29, 2013 3:39 AM | about stocks: GG, NEM

    Gold investing is an emotive subject especially for an industry which is barely represented in some major stock market indices. Gold does have an allure for investors concerned with potentially extreme Central Bank policy such as the expansion of the money supply via QE. Two charts from an Oxford Economics report commission by the World Gold Council in 2011 will suffice as an indicator. First, there are few assets that not only retain but increase their real (after inflation) price over time (certainly not equities or bonds and with equities it depends on the specific company):

    Second, there is a positive impact of gold ownership on broader portfolio results and balance as shown here under different scenarios unlike equities or bonds (gilts here) which under one or other of the more extreme economic outcomes significantly underperform.

    (click to enlarge)

    There is a strong rationale for holding gold-facing investments but after a strong run over the last decade, gold investors have been bought down to earth this year, especially those investing in gold mining equities. The Gold Bugs index ($HUI) - a sector index formed of gold mining companies - has halved in the last year as shown below despite a reasonable bounce in the last few weeks.

    (click to enlarge)

    If you were going to design the optimal gold company for today's environment it would probably have the following attributes:

    · Production growth potential;

    · Sustainably low cost of production / margin over the underlying gold price;

    · Legal and regulatory clarity;

    · Shareholder friendly management team

    Throughout this earnings season, I will appraise a number of the leading gold companies in the world on these criteria in order to search out opportunity as I like gold as an asset and the halving of the HUI seems more of an opportunity at current levels than a threat. Additionally I think weak hands have been forced out of their gold positions, an action I think they will come to regret.

    First to be appraised are two companies that have reported in the last day or so: Goldcorp (a US$22bn market cap company with its primary listing in Canada) and Newmont (the only gold mining company in the S&P500).

    The good news from the Goldcorp numbers is that they reiterated their production hopes and, as shown below, have plans to materially increase production over time.

    (click to enlarge)

    The less good news concerned not only a near US$2bn writedown in an underperforming gold asset but also that a rise in their 'all-in sustaining cost' (i.e. a measure of what it really costs the company to produce gold) had pushed up to nearly US$1300. As shown below this left a skinny margin versus the actual realised gold selling price despite their best efforts in reducing costs.

    So why is this? The company has growth scope as shown by hoped-for production extrapolations but the high all-in cost is crimping the company. The key is grade, otherwise known as the amount of gold in tonne of earth. It is not a given that high grade correlates with lower costs but it certainly helps on average. So what I did was to pace through the grade statistics in the Goldcorp Q2 report and check out the grade status of the company. Here is what I found:

    Grade % of Goldcorp production

    >5g 42%

    3-5g 8%

    1-3g 14%

    <1g 36%

    Goldcorp is a real 50:50 company. This makes it a geared play on the gold price but I am not feeling the real alpha here.

    Now turning to Newmont, they too reiterated their 2013 production hopes although fundamentally there is far less growth anticipated by the company's management over the next few years compared to say Goldcorp.

    (click to enlarge)

    Newmont's management too are focused on keeping costs under control and this chart shows the materiality of these cuts. Despite this I note the company did not generate free cash during the first six months of the year.

    (click to enlarge)

    And now onto the all-in sustaining costs. Newmont provide a range of these as shown below depending on certain specifics. In the actual Q2 report they define the costs more precisely as:

    All-in sustaining costs3 of $1,136 per ounce, excluding stockpile write-downs or $1,548 per ounce, reflecting stockpile write-downs;

    These numbers look a little higher than Goldcorp's. And what about grade? Well I struggled to find any information from Newmont on this issue in the release so I went back to their investor day in August last year and put together these statistics using the information provided for their various international mining divisions (not quite as precise as mine-by-mine).

    Grade % of Newmont production

    >5g 12%

    3-5g none

    1-3g 88%

    <1g none

    I think we can see why Newmont shares have struggled more than Goldcorp over the last year. It is not an attractive investment to me.

    I want to make gold investments at prevailing prices but neither of these two investments cuts it for me. Fortunately we have plenty of other industry heavyweights reporting in the upcoming weeks.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Stocks: GG, NEM
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