Gold Miners Have Missed Their Chance to Strike It Big

Barrick Gold, Newcrest Mining, and Goldcorp have missed their chance to strike it big, but they're now trying to clean up their act.

Jan 28, 2014 at 12:07PM

From the year 2000 to the year 2012, the price of gold rose six-fold. Of course, this was great news if you were invested in the yellow metal. However, it was also covering up something much more sinister, and now investors are paying the price.

You see, while investors and shareholders alike were mesmerized by the rising price of gold, gold miners could, in a sense, do whatever they wanted to. As a result, costs and debt shot up at miners like Barrick Gold (NYSE:ABX), and Newcrest (NASDAQOTH:NCMGY). But this is something Goldcorp (NYSE:GG) has apparently avoided.

Nevertheless, what goes up usually comes down, and the falling gold price has given these miners a stark warning: Cut costs and start behaving, or go out of business.

Changing landscape
During the past decade the gold industry has changed. Mega-miners now span the world with operations on multiple continents. In particular, Barrick Gold has grown from a relatively small company with sales of $2 billion during fiscal 2002 to a corporate giant reporting sales of $14.5 billion for fiscal 2012.

Unfortunately, this growth has created what Barrick has called "management layers," which is essentially a lack of integration and a fragmented management structure -- not an efficient way of running a business. To solve this problem, Barrick has cut 30% of its head office staff along with staff from regional offices around the world. These cuts, among others, helped Barrick to push down its all-in sustaining cash cost of production, or AISC, by 10% year on year at the end of the fiscal third quarter, to $916 per ounce.

Still, the company had to raise $3 billion in equity during November of last year to remain afloat, so it's not all good news. Although, with these changes taking place, Barrick should be in a better position to profit in the future.

Bigger is not always better
In addition to the creation of management layers, miners have also gotten caught up in the 'bigger is better' mentality. Sadly, Newcrest was the first to discover that, as it turns out, this strategy does not always work. Newcrest took a $5.5 billion writedown on the value of its mines last year when it was forced to acknowledge that due to the falling gold price and high cost of getting mines into production, some reserves would cost more to extract than they were worth.

Newcrest's confession was quickly followed by Barrick with an $8.7 billion impairment charge and admission that the company was selling some of its high-cost mines.

Further, it would appear that more writedown pain could be coming the way of Barrick and Newcrest.

Revaluation
All mining companies place a value on their reserves. This value is supposed to represent how much each mine is worth based on the recoverable gold within the mine. Of course, to value these reserves, mining companies use an indicative gold price. So, if a company believes that its mine contains 10,000 ounces of recoverable gold and the gold price is around $1,500 per ounce, then the company can value its mine at $15 million. Of course, this is only an example.

In Barrick's case, the company's gold reserves are valued at $1,500 per ounce, and Newcrest currently uses a figure of $1,400 per ounce to value its reserves. But with the price of gold falling, these miners will have to revalue their reserves, and this is likely to result in a writedown in the value of gold assets.

How much are these writedowns likely to cost? Well, according to Financial Times, Newcrest's management previously stated that a $100 per ounce fall in the price of gold would cut the value of the company's reserves by 7.6%. Barrick has said that a $300 per ounce fall in the gold price would see the value of its reserves fall by less than 10%.

Expensive acquisitions
The past decade has also seen a number of mergers in the sector, and for the most part these have been miners acquiring new reserves for often over-inflated prices. For example, Kinross Gold's acquisition of Red Back Mining for $8 billion back in 2010 eventually resulted in a multi-billion dollar writedown, and Newcrest's $10 billion takeover of Lihir Gold in 2010 also resulted in a $4 billion writedown .

But with valuations on the decline, Goldcorp, a company that has seemingly avoided much of the pain in the industry, is looking for vulnerable prey. Osisko Mining was Goldcorp's first target.

Obviously this move by Goldcorp was designed to take advantage of low industry valuations, but the offer for Osisko has been turned down, blasted by Osisko's management as "an immaterial premium which is well below those paid in relevant precedent transactions."

Osisko owns one low-cost gold mine within Canada and the company's management has argued the case that smaller miners like itself often generate smaller returns than larger peers. Nevertheless, I doubt Goldcorp will give up on this deal, as a Canadian mine will help the company diversify away from Mexico and the Dominican Republic, where the company has been hit by tax increases.

Foolish takeaway
In conclusion, gold miners have been misbehaving over the last decade or so but they are now getting their house in order. Luckily, Goldcorp has missed most of the pain and is now preying on smaller peers, which should pave the way for future growth. What's more, hopefully Barrick and Newcrest have learned from previous mistakes, and recent measures to cut costs and place suitable valuations on their assets will lead to long-term gains. 

As every savvy investor knows...
Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love. 

Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers