Identifying Bright Spots in the Choppy Gold Market

Goldcorp's potential to turn ship is coming into clearer focus.

Jan 31, 2014 at 9:02AM

The record plunge in gold prices in 2013 hurt more than just gold miners' margins. Amid efforts to safeguard dwindling profits, it became apparent that most gold companies had been mismanaged prior to the unprecedented price drop. Not only did gold miners add high levels of debt in the years leading to the price decline, but no decisive measures were put in place to arrest soaring costs.

Even as gold companies struggle to turn ship, the outlook remains largely bearish. Needless to say, there are a few shimmers of hope. For instance, India is reportedly planning an imminent review of its current strict gold import laws. Similarly, continued devaluation in emerging market currencies is rekindling interest in gold as a safety net.

Still, however, this is not enough. The reality is that mining is a long-term business, sometimes having 30-year horizons. Before this current bearish cycle plays out to completion, prices will oscillate repeatedly but the key sticking points (e.g. debt, costs, unfavorable economic policy) will remain. Investors need to pick gold stocks that will not only weather the storm, but that can also emerge ahead of the competition when the bearishness clears.

Goldcorp better positioned to restructure
For most of 2013, gold miners were plagued with asset charges. Barrick Gold (NYSE:ABX), for instance, took a $5.5 billion writedown in its Pascua Lama project in the Andes in mid-2013. Worse still, it recently warned that the project will take additional writedowns in the fourth quarter. In addition, Barrick Gold's CEO Jamie Sokalsky says that the company will recalculate its reserves at a gold price of $1,100 an ounce. This is the same company that had to raise $3 billion in equity in November 2013 in order to stay afloat.

Goldcorp (NYSE:GG) similarly suffered impairment charges in 2013, but not as great as its peers. It was not only able to avoid most of the woes in the industry, but as at the end of 2012, its gold reserves were valued at $1,350, this was marginally higher than all of its peers (gold reserves are appraised annually and values released along with full year results). In consideration of the fact that Goldcorp was able to avoid most of the industry pitfalls in 2013, it is likely to maintain its edge relative to its competitors going forward. This couldn't come at a better time.

Gold miners need a new approach to Africa, and they need it fast. Labor costs in the continent, which has close to 40% of the global gold reserves, are rising disproportionately. There are many contributing factors including a bulging middle class with an insatiable demand for the good life and new government policies, just to name a few. In South Africa, for instance, unions such as the Association of Mineworkers and Construction Union (AMCU), representing 17% of mineworkers, have previously demanded minimum entry level wage of $1,250 per month for underground miners -- this is well over 50% of what entry level South African underground miners currently earn.

Similarly, the issue of 'resource nationalism' is sweeping through Africa. In South Africa, come 2015, holders of mineral licenses in the country are expected to use local suppliers to procure 40% of their capital goods, 30% of their services, and a full 50% of their consumables.

It is not helping that Africa's landscape is changing against the backdrop of major economic policy changes in the U.S. The Fed's decision to scale back on the bond buying program has translated into higher interest rates, further limiting demand for gold and dashing hopes for gold price appreciation.

Goldcorp, however, because of its better relative position, will be able to handle these challenges more effectively. It can leverage its stronger financial base to reorganize its value chain in Africa and include locals as required by certain laws in its areas of operation. Similarly, it is in a position to bargain better pay for petulant mine workers.

Goldcorp's recent aggressive, though unsuccessful, $2.6 billion bid to acquire Montreal-based Osisko Mining Corp shows that it not only has the financial muscle to turn ship, but it is willing to try new things.

Goldcorp's ability to make acquisitions during these lean times presents an opportunity to selectively acquire gold refiners in the future to pad its earnings. Gold refiners (jewelry makers etc) are currently enjoying huge margins in light of low gold prices and high demand in Asia. Although this is a long shot, the point remains that Goldcorp has more options at a time when most of its peers have very few. Goldcorp could be the best way to play gold's bearish stretch.

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