It is a safe bet to say that 2012 will not be looked<br /> back upon with a great deal of fondness by the CEOs of the gold mining<br /> industry. From the executive suites of the largest gold miners to the<br /> smallest junior exploration companies, this past year will go down as<br /> the “annus horribilis” (horrible year) for investors in gold stocks.<br /> The S&P/TSX Gold Index will close the year down about 21%.
The following Pacifica Partners article was also published in the Financial Post
It is a safe bet to say that 2012 will not be looked back upon with a great deal of fondness by the CEOs of the gold mining industry. From the executive suites of the largest gold miners to the smallest junior exploration companies, this past year will go down as the “annus horribilis” (horrible year) for investors in gold stocks. The S&P/TSX Gold Index will close the year down about 21%.
It is a bit of a head-scratcher at first glance as gold has spent most of 2012 trading north of $1600 per ounce. Just a few short years ago, many companies were basing the economics of their projects on gold prices that were significantly lower. Current analyst estimates are that the gold stocks are discounting gold prices of about $1000/ounce — a significant discount to the current spot price of over $600/ounce. So what happened to make investors so disenchanted with gold mining equities?
One significant factor has been the skyrocketing of miners’ costs. The costs of everything from energy to labour to engineering have risen faster than the price of gold. This has crimped the profit margins of the mining companies. In turn, investors have taken an axe to the value of the reserves being uncovered by exploration companies. For the junior companies, this has made it a difficult environment in which to raise capital since a weak equity environment for gold companies’ shares has made investors skittish to invest in these companies.
The most recent illustration of the cost escalation issue comes from Barrick Gold. During its last quarterly conference call the company announced a continuation of cost escalations at its major development projects. Its capital cost estimates have risen by over $-billion for next year — after a significant cost increase announced during Q2 2012. To be sure Barrick is not alone – it is an industry wide problem and not limited to geography.
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South Africa has long been a major gold producer but as its reserves are increasingly deeper underground and grades are getting increasingly skinnier, the cost structure is adversely impacting the profits of the South African producers. In addition, significant labor problems in the country have impacted gold production in recent months.
As the industry CEOs try to placate investors by promising to evaluate projects based on their return on capital rather than production growth for the sake of growth, they hope that investors will begin to give their shares a second look. Many significant mega projects have been delayed or scrapped this year by the industry. In a world where gold production from mines has been virtually stagnant for the better part of a decade and where central banks are increasingly raising their gold reserves, some industry observers are starting to wonder if we have reached a point of “peak gold” where supply will no longer be able to keep up with demand. Historically, calls for peaks in supply of most commodities have been.
Globally, the grades of new gold projects are lower today and that has an impact on costs and therefore the economics of the mines. Some longtime veterans of the industry say that some of the projects being built or considered today would not have made it past preliminary discussions in “the old days.”
The challenges of the industry are significant but so are the opportunities for investors. The valuations have been compressed and investor expectations are low for this segment of the market. Sentiment levels have been a reliable contrarian indicator for trading opportunities in the gold sector. Right now, the negative sentiment towards gold stocks means they are not on too many investors’ to-do lists for 2013.
Pacifica Partners Capital Management Inc. Navigating a Sea of Opportunity
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Canadian Real Estate and Demographic Trends
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