It's been a very tough year for gold miners. Just take a look at the performance of Newmont Mining (NYSE: NEM ) , Barrick Gold (NYSE: ABX ) , and New Gold (NYSEMKT: NGD ) . Each saw negative returns of at least 20%, with Barrick losing almost half of its market capitalization in the past year.
The reason for such a disastrous year is simple.
Regardless of each company's fundamentals, reserves or cost structure, gold prices have been driving revenue down continuously for the past few months. Gold declined from $1,800 per ounce to $1,309 in a relatively short period.
But how far can gold fall?
At some point, gold has to reach a somewhat stable level. This has not happened, yet. But in the meantime, the market may be punishing too severely some of the best gold miners in the world. For example, although gold prices decreased 19% this year, Barrick has shed almost half of its market cap.
Such disproportional patterns make little sense. As gold approaches its fair value, it may be interesting for investors to revisit the prospects of some of the strongest gold miners, to search for undervalued opportunities with stable reserves and solid balance sheets. Such companies will most likely benefit the most from a normalization in gold prices. But before we review some specific companies, when will gold stop falling?
The right time to buy gold is approaching
First, to understand when the price of gold will bottom out, it's useful to remember that the price of gold and interest rates are heavily correlated. Real rates are the opportunity cost of holding gold, and therefore interest rate increases will make holding gold more costly. After all, gold doesn't pay interest or dividends.
On the other hand, rising interest rates are associated with positive macroeconomic data and vice-versa. If the economy is depressed, the central bank is more likely to set low interest rates and increase quantitative easing to promote lending and investment, but such measures will also have a negative influence on the price of gold.
Turns out that recent U.S. macroeconomic data shows the economy is making steady progress in recovering from the 2007-2008 financial crisis. At the same time, the default risk in some European economies and fears of conflict in the Middle East have lost momentum. This is causing investors to view gold as less attractive, because they now perceive a more stable, bullish global market.
Notice that what we have seen since 2011 is the opposite of what we saw in the 2008-2011 period: an increase in uncertainty, default risks and flat interest rates.
Such movements took the price of gold far away from equilibrium in the first place. Therefore, it is logical to assume that the price of gold will finally approach its fair level once the crazy demand for gold originated in the 2008-2011 turbulent period gets fully unwound. And looking at recent U.S. economic growth rates, this could happen soon. In the next year or so, gold could be trading at a price similar to 2007 levels, at around $1,000 per ounce.
Now, it's time to introduce some great gold miners that will benefit the most from a normalization in gold price levels.
Newmont: Still attractive
As gold prices normalize, the volatility and negative market sentiment surrounding names like Newmont is set to decrease, making it an attractive investment again.
Trading only at 9 times earnings, Newmont is currently focusing on cost control and improvements in free cash flow generation, which could lead to a higher multiple next year, regardless of the price of gold. In the latest earnings call, for example, Newmont announced a reduction in consolidated spending of $362 million and a reduction in capital spending of $458 million. Also, further progress in the Conga Project in Peru is expected to happen in the next two years. Conga has 6.5 million attributable ounces of gold reserves and 1.7 billion attributable pounds of copper reserves.
Newmont tried to pay $0.35/share in constant dividends since late 2011 and increased it once on March 2013, up to $0.425/share. This move turned out to be unsustainable, and the company ended up lowering the payout by 29% to $0.25/share. Still, at $0.25/share and with a forward yield above the 3% threshold, the company's dividend remains attractive.
New Gold: Well-protected against further gold price decreases
New Gold is yet another example of a miner that has been severely punished by the uncertainty of gold prices. But with a diversified development portfolio (in Canada and Chile) growing production, and with active mines in Canada, Mexico, the United States and Australia, this company offers probable reserves of 7.8 million ounces of gold for a very small level of geopolitical risk. Notice also that the number of probable reserves has grown more than 50% since 2008.
And although gold prices keep decreasing, New Gold has admirably managed to sustain an EBITDA margin as high as 31%. Even better, revenue grew 6% this year, thanks to increased production.
The secret? New Gold seems to have a very efficient cost structure. For each ounce of gold it produces, it is said to obtain a net margin of $319-$469. That should be enough to keep New Gold profitable even if gold prices reach the $1,000/ounce level.
Barrick: Strong production and safe reserves
Barrick has been the most punished gold miner so far. But after losing almost half of its market cap, adjusting its cost structure, and taking an $8.7 billion impairment charge in the latest quarter, mainly due to a massive writedown of the Pascua-Lama development project, Barrick seems to be recovering. The latest earnings call came in with EPS of $0.66, 18% above the consensus estimate of $0.56.
Keep in mind that Barrick may have lost half of its market cap, but it still keeps its diversified portfolio of mines intact. With Bald Mountain and Marigold in the U.S., Pierina in Peru, Buzwagi in Tanzania, and promising cost-efficient projects on the way (Pueblo Viejo Project), Barrick will definitely see better times in the medium-run.
Final Foolish thoughts
It has been a terrible year for gold companies. However, the weakness in gold prices won't last forever.
Now, the upside of lower gold prices is that it makes it easy for investors to see which companies are better prepared for tough times. And as prices normalize to levels similar to the pre-crisis period, we will find more than one interesting investment opportunity, simply because the market has punished gold miners way too much and because some still remain profitable despite the adverse circumstances. These could be strong buys. After all, tough times don't last, but good companies do.
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