The Titans of Gold Strike Again

It's fun to root for the little guy, but it's hard to view the big picture through a microscope.

Although I have consistently encouraged Fools to focus their forays into the precious-metals mining sector upon select intermediate and junior-scale producers, investors aiming to keep their fingers on the pulse of this sector must pay close attention to the titans of gold.

The Titanic begins to resurface
Barrick Gold (NYSE: ABX  ) may more closely resemble the Titanic than a titan at the moment, as the world's largest gold miner struggles to dig out from beneath the sector's most oppressive hedge book. With a headline earnings loss of $5.35 billion in the third quarter resulting from a non-cash accounting charge, investors continue to languish in the ill effects of Barrick's infamous price speculation. Some smaller rivals like Randgold Resources (Nasdaq: GOLD  ) face underwater gold hedges as well, but Barrick's hedge book was the pioneering ocean liner in a sea full of icebergs.

To fund the cancellation of the offending contracts, Barrick diluted shareholder equity to the tune of 12.5% with an offering of 109 million shares, and recently added a further $1.25 billion to long-term debt. Although the growing consensus for advancing gold prices renders these moves entirely necessary, Barrick's bitter medicine is certainly a tough pill for investors to swallow. Roughly $3 billion has been deployed thus far to reduce total liabilities from hedges and floating contracts to $2.8 billion as of October 28, while $2.1 billion in raised capital remains available.

Barrick expects to achieve its full-year 2009 production guidance of 7.2 million to 7.6 million ounces of gold at total cash costs of $450 to $475 per ounce. Adjusting for copper and other by-product credits, that cost could come in as low as $360 per ounce. Anticipating further cost reductions in 2010 amid production approaching 8 million ounces, Barrick's already-healthy operating margins appear to offer further room for improvement.

In the all-important quest for major producers to replace production amid a tightening global supply of defined resources, Barrick Gold leveraged a silver stream agreement penned with Silver Wheaton (NYSE: SLW  ) for a portion of silver production at Pascua-Lama to fund the purchase of a majority stale in the nearby El Morro project. Adding the potential synergies achieved through geographical concentration to the company's unrivaled economies of scale, the beauty of Barrick's overall operating profile is matched only by the hideous nature of those hedge-related liabilities.

A second opinion from No. 2
The world's second-largest producer, Newmont Mining (NYSE: NEM  ) , recorded a 13% cost reduction to just $404 per ounce. Yamana Gold (NYSE: AUY  ) CEO Peter Marrone accurately called the third quarter of 2008 a peak in industry-wide production costs, and results from the majors continue to confirm that reversal. Newmont ate the analysts' expectations for breakfast, beating the consensus by a 40% margin with earnings of $0.79 per share.

Unlike Barrick, Newmont is projecting higher gold production costs in 2010 as a result of rising fuel costs and unfavorable currency exchange rates. Because those particular cost drivers represent common inputs throughout the mining industry, this Fool finds Newmont's projections more indicative of the coming cost trend for the sector. Just as costs peaked for gold miners more than a year ago, I believe that they are now poised to resume their upward trajectory.

With another timely reminder that mine development plans and commissioning schedules are never etched in stone, Newmont cited the sluggish ramp-up of production at the world-class Boddington mine in Australia for the reduction in full-year production guidance to the low end of its prior range at 5.2 million ounces.

The quickening pulse of the gold miners
Echoing Newmont's experience with the Boddington mine, similar downward revisions to gold production estimates have emerged from some significant producers in recent weeks ... including Kinross Gold (NYSE: KGC  ) and Agnico-Eagle Mines (NYSE: AEM  ) . Given the continuing trend toward diminishing global gold production identified by Kinross CEO Tye Burt, these downward revisions collectively form yet another fundamental catalyst supporting widespread expectations for higher gold prices.

As a collective, gold miners face a daunting array of challenges in the years to come. In addition to the likelihood of rising production costs and the increasing scarcity of new discoveries to replace current production pipelines, miners must brace for the potential income-eating impact of a deteriorating U.S. dollar. Increasing scrutiny of the environmental impacts of gold mining appears likely amid an overdue cultural shift into greater environmental awareness. As gold prices rise, so too does the potential for protectionist measures ... or even nationalization of gold assets.

Risks and challenges abound, but careful investors can take solace in the expectation that each of these challenges is common to the industry as a whole, and therefore would ultimately be reflected in the price of gold. I continue to view the mid-tier miners as particularly well-positioned to confront these myriad challenges, and I recommend some measure of gold exposure for every Foolish portfolio. Now that you know what I think, vote in the Motley Poll below to voice your own Foolish perspective.

Gold is a hot topic on the blogs at Motley Fool CAPS. Join the free service today and see just how many Fools are taking the long view when it comes to investing in gold. The "Gold" tag at CAPS lists 47 potential investments; you'll find Christopher's comments on most of them.

Fool contributor Christopher Barker thinks you can guess which of the James Bond movies he prefers. He can be found blogging actively and acting Foolishly in the CAPS community under the name TMFSinchiruna. He tweets. He owns shares of Agnico-Eagle Mines, Kinross Gold, Silver Wheaton, and Yamana Gold. The Motley Fool has a gilded disclosure policy.


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