The Gold Rebound Is Coming

There is hope for the gold mining industry. Falling gold prices appear to have stabilized at around $1,250 per ounce. Analysts are hopeful that falling mine production in 2014 will help to bring supply closer to demand. All of the capital expenditures projects cancelled or deferred in 2013 will only create supply constraints further down the road, pointing to a stronger turnaround in the years to come.

The bad news
The price of gold is hovering very close to the estimated average cost of production including sustaining capital costs at or above $1,100 per ounce. This has left many miners with significantly reduced earnings. Yamana Gold's (NYSE: AUY  )  third-quarter 2013 earnings before interest, taxes, depreciation, and amortization of $206 million is a big drop from the $368 million it brought in for Q4 2012. Goldcorp (NYSE: GG  ) is in a similar situation, with its EBITDA having fallen from $807 million to $327 million in the same time period.

Many companies have been forced to cut back and sell off assets. After selling three high-cost Australian mines in 2013, Barrick Gold (NYSE: ABX  ) just decided to sell its Kanowna mine for $66 million. To help reduce capex, its expensive Pascua-Lama project was recently suspended as well.

The good news
In 2013 gold mine production actually rose an estimated 4.1% from 2012. Now the industry is shrinking production growth through reduced capex and a more selective investment process. These and future supply restrictions should help create a more balanced supply and demand situation, eventually boosting prices.

Goldcorp is a great example of industry trends. Thanks to projects like Pueblo Viejo ramping up to full production, the company expects that its annual gold production will increase to a range of 3.7 million to 4 million ounces in 2016 before settling down to between 3.5 million and 3.8 million ounces in the following years. While the supply of gold doesn't instantly respond to price changes, eventually it will. 

Kinross Gold (NYSE: KGC  ) is another miner slowly rationalizing its production. It cancelled its Fruta del Notre project in Ecuador after issues with the government.

Another great piece of news for the industry is that hot-money outflows have been partially counteracted by strong jewelry imports in China and India. It is estimated that between September 2012 and September 2013 China's consumption of jewelry, bars, and coins grew 30% and India's grew 24%. As the gold price stabilizes close to the cost of production, investors should slowly start to come back into the market, creating the next boom cycle.

Start searching for investments
The 2013 bloodbath has forced miners to bring their costs down, and many have little room left. The industry average cost of production including sustaining capital costs is estimated to be around $1,100 per ounce or more. The upside is that since the easy cost reductions have already been found, the price of gold doesn't have much more room to fall before many miners start to consider temporary shutdowns of their facilities.

In the first three quarters of 2013, Goldcorp produced 1.9 million ounces of gold with an all-in sustaining cost of $1,136 per ounce. Newmont Mining is another low-margin player, with gold production of 3.6 million ounces in the first three quarters of 2013 and an all-in sustaining cost of $1,137 per ounce. Kinross is not the highest-cost producer, but with all-in sustaining costs at $1,045 per ounce in the same time period, it doesn't have much wiggle room.

Low-cost miners
Not all miners are running expensive operations. In the first three quarters of 2013 Barrick Gold's all-in sustaining cash costs were just $919, and Yamana's were even lower at $834. The big difference between Barrick and Yamana is that Yamana only produced 0.8 million ounces of gold while Barrick produced 5.5 million ounces.

Look for growth
While Yamana and Barrick both run low-cost operations, Yamana is in a better position to grow. Its smaller production base means that producing an extra 0.25 million ounces of gold per year would provide a significant boost to its bottom line, while Barrick would need approximately seven mines of this size to provide a similar production boost. 

Yamana's conservative financials give it another advantage. Its 2012 gold reserves of 17.7 million ounces look tiny compared to Barrick's 2012 gold reserves of 140 million ounces, but Barrick assumed a gold price of $1,500 per ounce while Yamana used a far more reasonable price of $950 per ounce. Seeing as the price of gold is around $1,250 per ounce, Barrick's 2013 reserves should see a significant drop.

Bottom line
The price of gold is stabilizing, and the winners and losers are clear. Higher-cost producers like Kinross and Goldcorp face a number of challenges, while Yamana's low cost of production and small production base will help it focus on developing choice assets. The market is starting to calm down, and now is a great time to start shopping around.

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