After a sharp decline, gold-mining stocks probably are the most hated group in the market.
There are plenty of reasons for that. The metal has moved into bear-market territory, falling last week to $1,402 an ounce—26% off its all-time high of $1,900, hit in September 2011—including a jarring $134 drop on Monday. And despite the high prices of recent years, well above the less than $800 at which gold traded in 2008, the miners haven't been able to generate significant profits and free cash flow.
Many investors have given up on the miners, opting for direct gold exposure through exchange-traded funds such as the SPDR Gold Trust (ticker: GLD), which holds $50 billion of bullion.
Manuel Diaz/AP Photo
A mine in the Dominican Republic owned by Goldcorp and Barrick. Political risk is a major hazard for miners.
But mining stocks now look enticing, trading at or near multiyear lows, and the companies are trying to become more shareholder-friendly. In the past year two of the top miners, Newmont Mining (NEM) and Barrick Gold (ABX), brought in new CEOs and vowed change.
"In my career, I've rarely seen a group less well-liked than the gold miners," says David Steinberg of DLS Capital in Chicago. He notes that the widely followed Philadelphia Stock Exchange Gold & Silver Sector index (XAU) trades where it was in the late 1980s. "Relative to history, these stocks are extraordinarily undervalued, but I don't know when sentiment will turn," he says. His firm owns Barrick, Goldcorp (GG), and Kinross Gold (KGC).
Gold stocks were out of favor even before the recent plunge. At $28, a leading U.S. exchange-traded fund, the Market Vectors Gold Miners (GDX), is down 27% this month, 39% this year, and is at less than half of its 2011 peak. Looking at the fund's three largest stocks, Goldcorp has slid 24% this year, to $28; Barrick is off 49%, to $18; and Newmont is down 29%, to $33.
Downside in these stocks seems limited, barring a further collapse in gold prices. They could rise 40% if gold rallies back toward $1,700, where it started 2013.
Among this group, Goldcorp probably is the safest play because it has the lowest mining costs, the strongest balance sheet, the best growth outlook, and the largest market value at $22 billion. It aims to boost its annual gold output to about four million ounces by 2017, from 2.3 million last year, while many rivals will struggle to simply maintain annual production.
Once the industry leader and the only gold stock in the Standard & Poor's 500, Newmont has been a huge disappointment; its shares are below where they stood a decade ago, when gold was at $400. Its attributes include a broad global portfolio that makes it less dependent on a single mine. One of its innovative moves is a dividend linked to the gold price. At the current price, the quarterly dividend would be 25 cents a share—a yield of 3.1%. (The yield in the table nearby is based on its most recent payout, which was keyed to a higher gold price.) Newmont shares are no higher than they were in the late 1980s.
BARRICK IS THE RISKIEST of the three because it has the most debt, at $14 billion, isn't generating any free cash flow after heavy capital expenditures, and faces a big challenge with an enormous mine it is developing in a remote location at an elevation of 15,000 feet on the Chile-Argentina border. Chile has ordered Barrick to stop work on its side of the mine, due to environmental issues.
At a minimum, this probably will delay the mine's opening, which had been scheduled for 2014, and potentially drive up the cost, projected at $8 billion to $8.5 billion—already about double the original estimate. Barrick also faces pressure from the Dominican Republic for higher payments on the newly opened Pueblo Viejo mine, in which it has a 60% stake; the rest is held by Goldcorp.
JPMorgan analyst John Bridges downgraded Barrick last week to Neutral from Overweight, noting the company's "debt load and capital overruns are becoming problematic in an environment of weaker gold prices."
Last week the Wall Street Journal reported that Barrick is seeking to sell three of its Australian mines.
Barrick looks particularly cheap with a 2013 price/earnings ratio of five, but profit estimates could come down, due to lower gold prices. If gold rallies, Barrick probably has the most upside of the three.
Barrick is a poster child for the industry's woes, including higher operating costs, bad acquisitions, cost overruns on new mines, and political risk. Resource nationalism around the world is becoming a growing issue for miners. It's getting more difficult to get government approval for mines, and once they're operational, governments sometimes want to rewrite contracts and get higher taxes, knowing they have leverage.
One encouraging sign is that the industry is showing a new honesty about costs. In the past, companies emphasized "cash costs," which often were about $500 to $600 per ounce. But that ignored a slew of other costs, including those for maintenance and environmental remediation. Barrick, for instance, forecasts 2013 cash costs of about $635 an ounce and "all-in sustaining costs" of about $1,050; Newmont projects about $1,150.
LOW CASH-COST ESTIMATES are designed to impress investors with the industry's profitability. They also encourage host governments to shake down miners. "Governments are seeking to impose significantly higher taxes on us because they think we're making superprofits," said Goldfields CEO Nick Holland in a speech last summer. "The opposite is true."
Doug Groh of the Tocqueville Gold fund (TGLDX) estimates the industry's true all-in cost is about $1,350 an ounce, reflecting new mine development. Thus, miners aren't creating much value at current prices. Nonetheless, he sees reason for optimism, owing to "management turnover, better capital allocation, and reduced cost pressures." Further declines in gold price could lead to an industry shakeout that ultimately would be bullish.
The Bottom Line
With their shares at multidecade lows, the miners are minding costs and becoming more shareholder-friendly. They could rise 40% if gold rebounds.
Given the risks of individual stocks, a better option for investors could be an ETF like the Market Vectors fund or a gold mutual fund. Betting on junior miners, including those in the Market Vectors Junior Gold ETF (GDXJ), looks dangerous. Big miners, having been burned with bad deals, are less inclined to buy the juniors. The top-performing open-ended gold mutual fund in the past three years has been First Eagle Gold (SGGDX); Tocqueville is No. 1 over the past five years, according to Morningstar.
The monetary backdrop for gold looks favorable, as major governments around the world suppress interest rates and crank up the monetary printing presses. "Unlimited global monetary debasement is a reason to buy, not sell [gold]," tweeted Barron's Roundtable member and gold bull Fred Hickey of the High-Tech Strategist. The amount of gold in the world, an estimated 5.6 billion ounces worth $7.8 trillion, is a fraction of the global monetary base, and it's growing at just 1.5% a year.
Most investors have little or no allocation to gold and mining stocks. This could be a good time to get in. The metal and the depressed stocks offer a hedge against all the ills that can flow from monetary and fiscal profligacy around the world.
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