A Gold Giant's Grim Guidance

Newmont Mining's (NYSE: NEM) respite from bad news has turned out to be exceedingly brief.

In my last look at Newmont, I noted that the company had closed its hedge book. This means the company has joined the likes of Goldcorp (NYSE: GG) and Lihir Gold (Nasdaq: LIHR) in bearing the full brunt of fluctuations in the gold price. Since precious-metals investors tend to be pretty bullish on bullion, this decision was not met with derision.

That hedge buyback was one of the first actions taken by new CEO Dick O'Brien, who had previously been the company's chief financial officer. He also placed more than $1 billion in convertible debt. Though he couldn't have foreseen the credit crunch and dollar droop right around the corner, both of these actions proved very timely.

More importantly, these proactive moves provided a nice contrast to the prior stream of scrambles by the company in the face of unexpected challenges. These ranged from hydropower hiccups in Ghana to mine miscalculations in Nevada.

In that same piece, I noted the company's twin challenges of cost pressures and production declines. Those issues haven't gone away, and a rollicking gold price can only do so much to support the troubled operator.

In an SEC filing yesterday, Newmont revealed that its costs may exceed previous guidance, and that reserve replacement may fall short of 100% for the year. O'Brien elaborated on these issues in a presentation at the Denver Gold Forum later the same day.

Cost creep
While the company had formerly guided its per-ounce costs in the $375 to $400 range, that hinged on improvement at the Phoenix mine in Nevada. Newmont has since learned that its understanding of what it had in the ground was pretty deeply flawed. After accounting for the re-drilling and mine model revisions that are lined up over the next few quarters, it's looking like Phoenix won't be ready to rise from its ashes for quite some time.

Add in the work stoppage at Midas mine in Nevada, stemming from the fatality that occurred there, and you're talking about nearly half of Newmont's current production going haywire.

Lest you despair, there is a silver lining here, albeit a strange one. With a higher cash production cost, Newmont actually has higher leverage to the gold price. This works like any other kind of leverage, and it obviously cuts both ways. The firm shares this dubious distinction with dilutive IAMGOLD (NYSE: IAG) and discordant Harmony Gold (NYSE: HMY).

Reserves in retreat
Newmont is somewhat analogous to the oil majors, in that it has tended to focus on elephant-sized deposits. But it's now facing some particularly acute reserve replacement issues. It has replaced its production for five years running, but 2007 may end that streak.

The size and age of Newmont's mines may help Fools understand the phenomenon. Phoenix, for example, already had most of the high-grade reserves carved out of it by the time Newmont purchased the property in 2001.

The company acknowledges that, given its scale and the lack of sizable discoveries, it can't rely on exploration alone. O'Brien outlined an approach that involved looking at bringing a broader array of smaller producing and near-producing assets into the portfolio. This would ostensibly smooth out the production profile and provide greater visibility. Seems sensible to me.

The Foolish bottom line
O'Brien was understandably on the defensive yesterday. He spoke about accountability, which is certainly important, even though he inherited these problems. Still, he's the one who has to get the firm back on its feet. If O'Brien leads as forcefully as he speaks, there's a decent chance we'll see more positive changes over the quarters and years to come. I look forward to watching things develop from the comfort of the sidelines.

Related Foolishness:

• Yamana is dead. Long live New Yamana.
• Here's a look at another gold miner dealing with power problems in Ghana.