China Passes the Hot Potato

by RJ Wilcox on June 14, 2013

Chinese Flag & Stack of Gold CoinsHello and welcome to the inaugural Gold Miners Weekly Recap. Since this is the first weekly recap, an explanation of the information you will find here and on our homepage is probably appropriate.

On the Gold Miners homepage (www.goldminersreport.com), under the Daily Market Insight tab, you will find the News Corner. Presented there is a continuously updated slideshow that includes news content relating to gold, the gold market, gold mining companies and the gold mining industry.

The content is specifically selected and summarized by our editors, which includes yours truly, from stories we feel are the best and most relevant relating to and surrounding gold.

At the end of each week, the News Corner stories will be transferred into our News Archive that serves as a valuable place to locate important information regarding gold and the gold mining industry for investors.

The weekly recap will report on the weekly price activity of gold, major gold market indexes, and noteworthy developments in the gold mining sector.  We will also highlight the common thread that ties these daily news stories together, and will offer the editor’s perspective on how this theme affects the gold market and its participants.

With the formalities out of the way let’s recap the first week…

Gold

The gold price edged slightly up this week, opening at US$1,383.05/oz. and closing at US$1,391.50/oz.

In comparison to some very volatile recent weeks, gold trade was quite somber.

Asian demand was muted due to early week holidays in China and demand out of India was curtailed due to another government imposed gold duty increase of 2%. In the U.S., Federal Reserve posturing on if, when and how much quantitative easing tapering would occur kept gold traders glued to the news feed.

The chart below illustrates the daily gold movements for the week.

Screen Shot 2013-06-16 at 4.53.38 PM

Gold Mining Shares and Indexes

To get a general idea of how the shares of gold mining companies have historically traded or to gauge the current trend, there are two major indexes to monitor, the HUI and the XAU. Let’s take a brief look at these two benchmark indexes to familiarize you with each.

The HUI, or the AMEX Gold BUGS index, is strictly composed of un-hedged gold mining companies. The term un-hedged simply means that these companies do not enter into contracts to sell their future gold production based on a fixed price, set at the time of the contract.  Instead, they sell their production at whatever prevailing spot price is at the time of sale.  An un-hedged approach generally reflects a bullish mindset.

The HUI is made up of 16 companies divided into two groups of 80% large-cap companies and 20% mid-cap companies. Three examples of large-cap companies currently included in the index are Barrick Gold Corp., Agnico Eagle Mines, and Anglo Gold Ashanti.

The XAU, also known as the Philadelphia Gold and Silver Index, is similar to the HUI except that the index includes companies that produce silver as well.  It also does not discriminate against companies that might hedge the price of gold, although this is a somewhat rare phenomenon in the current market.

Overall, share prices this week performed poorly in comparison to gold. Currently affecting the broad sector is some negative company specific news that is being attributed to all majors.

The HUI ended the week down 2.5%. The graph is below for those that are visually orientated.

Fruta del Norte

Clearly, this week’s noteworthy gold mining company news was the decision made by Kinross CEO, Paul Rollinson, to abandon the Fruta del Norte (FDN) gold project in Ecuador. Kinross acquired the FDN project through its acquisition of Aurelian Resources in 2008.

The FDN deposit is impressive and considered one of the largest undeveloped high-grade gold projects in the world. However, since the discovery of the coveted deposit, its future development potential has been uncertain which has tormented company executives and shareholders alike.

Before the recent abandonment decision, Kinross had been negotiating with the Ecuadorian government for more than two years, trying to reach an agreement on the amount of taxes to be paid once the mine began production.

Ecuador wanted a 70% windfall profit tax, a rate Mr. Rollinson could not accept. His decision to walk away from the project will result in an approximate US$720 million write down which will be charged to the company’s second quarter results. Kinross stock dropped 5% on the news.

The Kinross, FDN, Ecuadorian saga illustrates an extremely important point that should always be considered when making an investment in a gold mining company.

The general question to ask is, where are the company’s prospective and currently operating mines and what are the risks associated with those countries?

Following this question, an investor should determine what percentage of the company’s overall asset’s a mine will represent? Investors should be wary of a company where 40% of its asset’s reside in a place like Ecuador!

For our newsletter subscribers, we have developed a proprietary analysis tool (i.e. J-Score) to help us score and rank gold producers based on the risk level of the countries in which they operate and amount of gold reserves held in these jurisdictions.

The Fruta del Norte project is a painful reminder to investors that they must be attentive to the risk of doing business in various countries. Always remember, a company can own the rights to one of the biggest and best gold deposits in the world but if it is located in the wrong country, it is literally worth less than zero.

One last item worthy of mentioning is the ongoing stream of large scale asset write-downs taking place among the major gold miners.  In recent months majors Barrick and Kinross have reported write-downs measured in the billions of dollars.

These asset write-downs are the result of acquired projects not performing to expectation or development projects running enormously over budget.  This week Newcrest, the Australian major, announced its own write-down of $6B.

China’s Big Week in the Gold Market

Another prevalent theme in the news this week was China and the influence it had in the gold market. This probably won’t be the last time we will make this statement.

This week alone, China approved two gold-backed exchange traded funds, announced an off-take agreement with Russia’s leading gold production company, is rumored to be a potential buyer of the Fruta del Norte gold project, and rumored to be cornering the gold market through secret sovereign wealth funds.

There is also big news coming out of Ghana, Africa’s second largest gold producer, as the government has arrested over 150 alleged illegal Chinese immigrant miners.  Chinese have been flooding into the country to cash in on Ghana’s gold boom, bringing with it considerable social conflict.

That’s a big week! Or is it? Maybe there are bigger weeks ahead for China and the gold market?

Currency Wars

Since we’re on the China theme, Currency Wars is an outstanding book written by James (Jim) Rickards. A currency war occurs when one country devalues its currency relative to others to gain a trade advantage. In Currency Wars, Mr. Rickards eloquently explains what he calls “Currency War III”, a time period we are currently experiencing and began in 2010.

One front in this war he calls “The Pacific Theater” entails the contentious financial relationship between China, the United States, and the battle between the yuan and the dollar.

Very generally, “The Pacific Theater” boils down to the U.S. belief that China is keeping the yuan artificially undervalued to support its exports and employment, and China’s worries about U.S. monetary policy, the value of the dollar, and the affects of both on its economy.

Rickards suggests two options he believes China will pursue in its currency war with the U.S.  The option of particular interest, which is extensively evidenced through this week’s plethora of News Corner stories, is that China has been and will continue to invest its hot-potato dollars in commodities such as gold.

China is clearly focused on acquiring gold. They are doing so to protect the value of their massive U.S. denominated currency reserves (est. US$2T – US$2.3T) from a declining dollar and to strengthen their currency by backing the yuan with gold.

China’s accumulation of gold and gold assets is one way they are fighting their currency war with the U.S. and just one of many reasons why we at Gold Miners see future price appreciation, or more accurately, sustained real purchasing power resulting from investments in gold and gold related assets.

If this discussion on Currency Wars has interested you, we strongly recommend purchasing a copy of Jim Rickards’ book. We read it as soon as it was released in 2011 and so far its been an excellent road map to help navigate the ongoing “Currency War III.”

And that’s it.  We hope you have enjoyed this weekly recap. If you are interested in a more in depth discussion surrounding topics like this one and specific gold company analysis, click on the link below.

Gold Miners

Until next week…

{ 0 comments… add one now }

Leave a Comment

{ 1 trackback }

Next post: