Mining Executives Quit and Get Jobs at Fed

by RJ Wilcox on June 28, 2013

Intro

Before diving into the Weekly Recap we present an abbreviated version of our Comparative Analysis Table for your reference and ours.  It compares the operations of 12 of the top gold producers as measured by market cap.

It is a sampling of our in-house analysis customized to capture the key metrics of the gold mining business.  The complete table, available to subscribers, encompasses a long list of producers and a mountain of painstaking data gathering that we keep updated on a monthly, quarterly and annual basis as the information is released.

GM Proprietary Comp Table

(Click to enlarge)

Weekly Recap

During the past two-weeks I have been fortunate to be entertained by the culmination of two amazing sports playoff series, the NBA finals and the Stanley Cup finals. To be honest, both series were so good that I didn’t care who won, I just wanted to watch.

Sports have played a large role in my life and as a result I regularly see analogies in the market that spill over into my commentary.  Plus, it’s a topic that many can relate to.

With that said, I have some questions for you; do you think the Miami Heat would have won the NBA Championship without Lebron James? Do you think the Chicago Blackhawks would have won the Stanley Cup without Patrick Kane? Yeah, me neither…

My last question before I get to the main event is… what do you think will happen to the stock market and the bond market without its best player, Quantitative Easing? Yeah, me too…

Hedge Funds Can’t Handle their Booze Gold

Gold began the week at US$1,291.40. Things got interesting on Wednesday, when gold traded down to a session low of US$1,221.10 and closed at US$1,225.20, registering yet another scary drop of $52.40 or 4.2% on the day. The fireworks continued on Thursday when gold dropped below US$1,200 for the first time since August 2010.

As you may be aware, there are many factors that influence the gold price. The one I want to discuss today is interest rates. Last week, I talked about the substantial 55% climb of the 10-year U.S. Treasury rate that has occurred since May. This week, the rate continued its ascent, rising a slight 5 basis points to 2.52%.

A rising 10-year rate increases the borrowing costs of money for everyone. Along these lines, you may have noticed that mortgage rates have surged higher, for their biggest one-week increase since 1987. The rising 10-year rate is the leading instigator.

Most people have heard of the opaque entities called hedge funds. Very simply, hedge funds are privately managed investment funds that invest in a large range of assets, generally on behalf of the wealthy and large institutions. To provide some context, the amount of money hedge funds manage is estimated to be US$2.13 trillion.

Important to my discussion of this week’s gold price activity is that hedge funds use a sizable amount of leverage, meaning they borrow a lot of money. They also use the borrowed money, along with their capital, to purchase market securities utilizing margin, another form of leverage. So essentially they use leverage on leverage. Sound safe?

Hedge funds have been very active gold market participants, many of them investing on the long side (betting gold will go up).  They use the borrowed money to dramatically increase the size of their positions, and thus the size of their profit potential. Given the amount of money they control in this fashion, hedge funds can significantly affect the markets they invest in.

In a rising interest rate environment, such as the one we are in now, hedge fund’s borrowing costs go up along with everyone else’s.  When interest rates rise dramatically, as they have recently, their borrowing costs also increase dramatically and can trigger the dreaded margin call.

When hedge funds purchase a market security on margin, they only put up a small percentage, often single digits, of the total cost of the investment. If the value of that investment declines, they have to put up more money to maintain their position. If they don’t or can’t come up with the extra margin required, the lender will be forced to liquidate the position to retrieve their loan.

The point of all this is that an important component of the current sell-off in gold has been hedge fund liquidations related to rising borrowing costs and a declining gold price, which in turn has triggered margin calls.

It is said that selling begets selling. It becomes selling on steroids when extreme margin and large amounts of leveraged investment capital are involved.

Below is a visual of the gold price waterfall for the week.

June 28 Gold Weekly(click to enlarge)

Welcome, Let’s Play Mining Exec “What Do I Do Now?”

Just as the gold price was roughed up, so were the gold mining shares. Opening the week at 225.02, the HUI currently sits around 221.65, a drop of 1.5%. However, as you can see below, as I submit my recap, the HUI is mounting a Friday charge.

Here is a graph showing the HUI index.

June 28 HUI Weekly

(click to enlarge)

There is no question that the shares of gold miners have been a disaster for the last 20 months. The historic increase of gold from the US$300 level in 2001 to almost US$1,900 in 2011 seemingly gave gold mining executives a large margin of error to operate within.

During this time, executives worked overtime to amass reserve ounces and grow production, often through very costly acquisitions. In their defense, this is what shareholders wanted; companies with growth profiles. But then, when the gold price peaked and began its precipitous decline, the margin of error disappeared and, in many cases, so did the executive’s job.

In recent weeks, I have highlighted massive write-downs by majors such as Barrick and Kinross. Newcrest recently joined the pack with their own record setting $6 billion write-down, which will most likely be followed by other gold miners in upcoming quarterly results.

Recent reports indicate that the industry has already taken a cumulative $17B hit, including Newcrest. With the gold price receding, many of these expensive acquisitions are performing far below expectation, and hence the write-downs.

Now, amidst a dismal gold price environment and poor share performance, the growth at all costs mantra has been replaced by a new focus on profitability.  Who knew… profits are important!

On Thursday, the World Gold Council officially announced two new methods of calculating and reporting costs related to mining gold. The idea is to make reported costs more accurately reflect true mining costs and to make companies more transparent with investors.

The methodology revolves around what’s being called an all-in cost that takes into consideration the direct, varying, and sustaining costs associated with producing an ounce of gold.  This is now considered the preferred method over the previously used cash-cost metric.

Some miners had already been using this method and it has been a welcome change

Associated with all-in costs, the major theme coming from mining executives and analysts this week was the questionable sustainability of gold mining operations and companies at current gold price levels.

Estimates between companies vary, but the all-in costs for the major gold miners ranges between US$1,100 – $1,900. This range puts the average all-in cost of the gold mining industry at roughly US$1,350. Our own in-house analysis, using a comprehensive all-in cost calculation, agrees with this assessment.

As you may have spotted, the gold price is much lower than that average, which means, on average, the gold mining industry is not profitable.  There were reports this week that perhaps a third of the industry is underwater.

For fun, let’s pretend to be a mining executive and assess the current predicament in the gold mining industry. On one hand, you have a declining gold price that is already less than your all-in cost. On the other hand, your all-in cost is simultaneously increasing from higher taxes, labor, material, and energy costs.

Besides quitting, and applying for a job at the Federal Reserve, let’s consider your options, as a mining executive, to make your gold mining company profitable in this environment.

One option, evidenced by recent news stories, is to cut jobs. The mining industry cut approximately 1,000 jobs this week with large gold miners such as Barrick Gold and Newcrest Mining leading the way, axing 100 and 250 jobs respectively.

Another option, also receiving a considerable amount of news coverage, is mine suspension or closure.  It might surprise some to know that, shuttering an operating mine (aka putting it into care and maintenance) is not an easy or inexpensive proposition, nor is restarting one for that matter, and thus is typically the last resort.

Some other options that you, a mining executive, might explore before mine suspension and closure are alternatives such as:

  • Cost cutting and lay-offs – Certainly will not make you very popular at the office!
  • Terminating exploration projects – How will you replace reserves?
  • Terminating mine development projects – Production growth?
  • Production cuts
  • Stockpiling low-grade ore
  • High-grading

High-grading and stockpiling ore are usually performed together. High-grading simply means that you process high-grade ore before lower-grade ore and set aside the low-grade to process when prices are higher.  This is a viable option in today’s gold price environment.

Putting off new developments and exploration projects will save money but it won’t serve its purpose and replace the reserves you are currently mining. When you run out of reserves to mine, then what do you do?

One of the companies we at Gold Miners follow pretty closely is Goldcorp. You will notice from our Comparative Analysis Table above that Goldcorp has 11 mines and an average all-in cost of US$1,238. If the gold price stays at its current level for an extended period of time and you were forced, as CEO, to suspend or close a mine, which one would it be?

Generally speaking, it would most likely be the highest cost, lowest grade mine or some trade-off between these two factors. At the risk of oversimplifying the process, if we look at Goldcorp’s 11 mines, the Marigold or Wharf mines would be candidates for closure because they are the best fit for our criteria of high cost, low grade.

By the numbers, the Marigold mine has a cash cost of $854 and a grade of 0.52 grams per tonne (g/t). The Wharf mine has a cash cost of $836 and a grade of 0.82 g/t. The average cash cost of all Goldcorp’s mines is $565 with an average grade of 0.80g/t.  In comparison, at the other end of the spectrum, is their Marlin mine which has a low cash cost of $102 and a high-grade of 4.18g/t, making it very profitable

As you now take off your pretend mining executive suit, you can see that gold mining companies are currently experiencing very difficult times. Solving their predicament of low gold prices and high mining costs is not an easy task. The decisions that need to be made are accompanied by many tough and complicated factors.

But don’t despair my mining exec friend, help is on the way. The physical demand side of the gold equation is very strong. This week we witnessed further historic draining of the Comex gold inventory. Their gold stock is likely flowing into China, Russia or Kazakhstan whose central banks are continuing their heavy gold buying ways.

Also, the Vietnamese retail gold investors have your back and are so eager to purchase the country’s very limited supply that they are willing to pay a $217 premium above the spot price.

Lastly, our friends at the Fed will come to your aid, printing oceans of new money, regardless of the smokescreen called tapering, to solve their problems and yours. Just yesterday, William Dudley, the president of the Federal Reserve Bank of New York, reiterated that the Fed would continue its bond-buying program if economic performance did not meet forecasts.

Give them enough time and they will print so much money that people will have no choice but to protect themselves from the erosion of their currency holdings in large part by purchasing gold and gold mining stocks.

Jim Rickards Takes Interview Tips From Ricky Bobby

I want to end another tough week for the gold crowd on a lighter note. First off, my disclaimer… I think Jim Rickards is an incredibly intelligent commentator who eloquently expresses his opinions. I am also a big fan and used his prolific Currency Wars book as reference for my first weekly recap at Gold Miners – China Passes the Hot Potato.

With that out of the way… I was enjoying some couch time earlier this week and Talladega Nights with Will Ferrell was on TV so I decided to watch a little.

One classic scene from the movie is when a nervous Ricky Bobby is interviewed on live television for the first time and doesn’t quite know what to do with his hands. As a result, during the interview he unconsciously raises his hands in front of his face while the interviewer makes subtle attempts to push them back down.

You can watch the humorous clip here: Talladega Nights Interview with Will Ferrell. (1min)

I follow Rickards pretty closely and review everything I can of his. While watching his ABC News June 25th interview titled, Slashing Rates a Big Mistake, I noticed an uncanny similarity between Ferrell and Rickards. Watch the hands …

It’s annoying when someone points out the sound of a ticking clock you didn’t hear before. Then, after they have told you to listen for it, that’s all you can hear. Well, I’m sorry if I’ve just done this to you. I’m sure the next time you watch a Rickards interview you will probably focus on his hands and not the important things he is saying

From now on, you’ll have to watch Rickards’ videos twice. You probably should anyways!

That’s it for this week. Hope you enjoyed this week’s recap. If you want, check out our homepage: www.goldminersreport.com and sign-up for a free copy of our June newsletter.

Regards,

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