Source: Forbes – How Gold Miners Became A Terrible Investment
It’s tough to find an entire investment sector that has tumbled by 50% this year, but that’s how far the shares of gold mining companies have fallen in 2013. The price of gold, of course, has also plunged in 2013 by some 25% to $1,240 an ounce. But gold mining stocks have performed much worse than broader market indices and even gold itself.
For nearly eight years now, shares of gold producers have underperformed in a very bad way, which is remarkable because until recently these companies were operating in the most favorable gold price environment imaginable. This year will probably be the first time since 2000 that gold will have a negative annual return. Gold mining companies, however, have managed to underperform gold in both good gold markets and bad—with the under performance getting exceptionally ugly in the down times. Gold miners have given investors little upside when the price of gold rises and handed them serious losses when gold falls. Gold producers have consecutively underperformed gold since 2006, Deutsche Bank notes in a recent metals and mining report. They only outperformed gold in four instances in the last 12 years as gold soared starting in 2000 from a decade of lows to a high of $1,900 an ounce in 2011. For gold miners, all the over performing years came prior to 2006.
The stock performance of gold producers has been a huge disappointment for the investors who piled into this sector, convinced it would benefit from rising gold prices that were being driven by fears of currency instability as national governments intervened in financial markets. Gold miners became the stomping ground of retail investors, billionaires like George Soros and Thomas Kaplan, and big shot hedge fund managers, like John Paulson and Jeffrey Vinik.
In a 2006 cover story called Gold Rush, Forbes warned investors to watch out for promoters who were pushing iffy mining companies as the price of gold rocketed. Speculative companies like NovaGold, which had a market capitalization of more than $1 billion at the time and whose big project has gone nowhere in the seven years since, were questioned. Another gold mining company with nearly a $1 billion market capitalization at the time that was highlighted, Crystallex International, saw its shares delisted. The gold company of Mark McEwen, who was pictured sitting on a pile of gold bars in Forbes Magazine and whose personal stake in the company was valued at $125 million in 2006, has seen its shares fall by 80% since the day the article was published. Every company profiled in the article has been a dud.
In total, gold mining companies spent $45 billion on projects and acquisitions since 2010 with another $15 billion of spending still scheduled, but gold output has declined to 17.4 million ounces from 18 million ounces in 2010. Deutsche Bank put out a report recently called “The End Of Big Gold?” questioning if the big capitalization North American gold producer model is “fundamentally broken.” The report pointed to the rise of resource nationalism and tax grabs, accounting measurements that mask true operating costs, an over reliance on equity issuance to fund capital expenditures and acquisitions—and huge cash pay packages to gold mining CEOs that have nothing to do with share performance. This last problem does not appear to be changing: A year ago Barrick Gold, the world’s biggest gold producer, hired John Thornton, a former Goldman Sachs president, as a likely successor to founder Peter Munk, and put together a $17 million pay package for Thornton that included a $12 million signing bonus. Barrick’s stock has fallen by 56% this year.
One of the big reasons that gold producers did not benefit as much as some investors believed they would from the rising price of gold was the introduction of gold exchange traded funds that easily gave investors exposure to gold. Now that the gold price has crashed, gold mining firms that took on lots of debt and stretched to attempt long-shot projects are in trouble as the costs associated with mining increases. The write-downs have begun, with Australia’s Newcrest Mining announcing last month that it will likely take a write-down of as much as $5.7 billion on its gold mines. Barrick just announced it would take a write-down of as much as $5.5 billion on its big Pascua-Lima project and other significant impairment charges on some of its other assets. “Write-downs to be a significant theme in the gold space,” a Credit Suisse report said last week. “Gold producers are required to test assets for impairment whenever indicators of impairment exists.”
The math for most gold mining firms has become very harsh. Many Wall Street banks in June were analyzing gold mining projects with a bear case scenario of gold at $1,300 an ounce, a price that gold has already crashed through. A BMO Capital Markets table making the rounds at hedge funds and investment shops recently showed that most gold producers are trading at very high multiples to their net present value with spot gold at $1,300 an ounce. Deutsche Bank noted that at $1,300 per ounce of gold “a vicious cycle emerges forcing companies to likely raise equity to bridge a growing funding gap until they ‘right-size’ costs to the new gold price.”
If gold remains stuck around $1,300, investors in gold producers seem headed for a cash crunch. Barrick, for example, had a cash balance of $2.3 billion and debt of $15 billion at the end of the first quarter. Its use of cash was recently estimated by Deutsche Bank to be $1,813 an ounce. Goldcorp’s use of cash is estimated to be at $2,016 an ounce. Gold producers could choose to deal with their issues by reducing costs, cutting dividends, selling assets and halting work at higher-cost mines, raising net present values but potentially causing some cash charges. Barrick just announced it was laying off 30% of its office staff at its corporate headquarters Deutsche Bank had recently estimated that if Barrick had maintained its dividend and project plans in a $1,300 gold environment, it would have had to raise as much as $9.8 billion in equity.
For Barrick, the giant Pascua-Lama gold project located on the Chilean-Argentine high-altitude Andes is emblematic of what has gone wrong. Higher costs to mine a product whose value has diminished. On Friday, Barrick delayed its plans for first production at the mine nearly two years to the middle of 2016. Barrick had to suspend work on the Chilean side in April, where most of mine’s ore body sits, because of a Chilean court’s preliminary injunction that was issued due to the environmental concerns of indigenous communities. Chile’s Superintendent of the Environment in May required Barrick to complete its water management system for the project in accordance with an environmental permit before resuming construction. On the Argentinian side of the project, where most of the critical infrastructure is located, labor costs are soaring.
While shareholders of gold mining companies have suffered losses, the executives of these companies have not felt the pain so much. Aaron Regent was paid $12 million, mostly from a severance package, after he was fired as CEO of Barrick last year. In total, Barrick management was paid $57 million, a 148% year over year increase while the stock was headed in the opposite direction. Newmont executives got $30 million, up 31% and Kinross’ executives received $39 million, a 54% increase. These execs may have won, but their shareholders have lost big time.