Regardless of the industry, stocks don't often go up in a straight line, and precious-metal investors found this out the hard way during the month of August.
Up until August, gold miners were among the top-performing sectors for 2016, but the VanEck Vectors Gold Miners ETF, which holds some of the largest gold miners in the world, dropped nearly 17% last month. Some of the worst-performing gold mining and royalty companies for the month of August were:
- Newmont Mining (NEM -0.74%): down 13%
- Yamana Gold (AUY -0.36%): down 29%
- Royal Gold (RGLD 0.18%): down 13%
- IAMGOLD (IAG -1.43%): down 28%
- Barrick Gold (GOLD -0.42%): down 22%
- McEwen Mining (MUX -1.49%): down 23%
- Kinross Gold (KGC -1.43%): down 23%
What caused such a tumble, you wonder? I'd single out two factors in particular for the slump.
Two reasons gold stocks suffered a meltdown in August
Without question, the biggest concern for physical gold during the month of August was the continuation of improved U.S. economic data. In July 2016, the U.S. economy added 255,000 jobs when only 180,000 was forecast by economists. With the exception of May's brutally bad jobs report, new job creation has been stronger than most analysts have forecast.
Stronger than expected growth in jobs could imply that the U.S. economy is gaining traction, which would be one of the primary reasons for the Federal Reserve to consider raising interest rates. If you recall, the Fed entered 2016 with a consensus expectation of raising interest rates four times, but previously sluggish economic data, and the announcement that Britain is planning to leave the European Union, halted those plans.
Interest rate hikes are important for two reasons for gold-mining stock investors. First, higher lending rates make it more expensive to borrow capital to finance the development and buildout of mines using debt. This means miners have to be smarter about how they deploy their capital. More important, though, higher lending rates usually push yields for bonds and CDs higher. As these interest-based assets grow in yield, the opportunity cost of choosing to invest in physical gold, an asset that has no dividend yield, increases. If this opportunity cost grows substantially, we could see physical gold investors trade out of gold in favor of the near-guaranteed returns of bonds and CDs.
The other issue can likely be traced to 13F filings with the Securities and Exchange Commission in mid-August. 13F filings are required by investment firms with at least $100 million in qualifying assets. Of particular interest was billionaire George Soros' fund, which despite remaining quite bearish on U.S. stocks as a whole, sold off some of his gold holdings. The move could be nothing more than simple profit-taking, but it seems an odd move to make with a continued bearish view on the market since gold is often viewed as a downside hedge to stocks.
Of course, investors probably aren't complaining since the vast majority of gold miners are still up handily over the trailing year, as you can see below.
This is a buying, not selling, opportunity
Despite the rough month, I'd opine that now is not that time to be scared out of your shares of gold miners.
Prime on the list of reasons why is the aforementioned opportunity cost of trading off gold for interest-based assets. Even if the Fed decides to raise lending rates in September, we're still looking at U.S. Treasury bonds and bank CDs that'll be yielding near or below the current inflation rate, and well below the historical inflation rate average. Investors who get "stuck" in interest-bearing assets at low yields are probably going to regret the move later, which continues to make gold an attractive investment opportunity.
However, the best reason to buy gold miners could simply be their drastically improved fundamentals. Each and every one of the miners above is benefiting from either reduced costs that have lowered their all-in sustaining costs to attractive levels, or production expansion opportunities that should greatly expand their cash flow in the coming years. In many respects, the gold miners above are deeply discounted value stocks.
For example, Kinross Gold and Barrick Gold are the respective cheapest miners in the industry based future free cash flow (for Kinross) and AISC (for Barrick). After years of asset write downs, Kinross is boring full steam ahead in boosting milling capacity for its Tasiast mine in Mauritania. By the first quarter of 2018, Kinross anticipates an 87% increase to production with a better than 45% cut in AISC at the mine.
Meanwhile, Barrick Gold has repaid more than $4 billion in debt over the past year-and-a-half and remains on track to reach $5 billion in outstanding debt in the intermediate-term. The company has also cut its capital expenditures in half from four years prior and is reinvesting in only its top-tier projects. With an AISC midpoint of just $770 an ounce in 2016, Barrick has a wide margin of safety.
Royalty-mining stock Royal Gold may not be "cheap" in the same fundamental respects as Kinross or Barrick, but it's perhaps the most primed to take advantage of physical gold's ascent. Royal Gold works out long-term or life-of-mine contracts with miners in exchange for upfront cash to develop or buildout mines. In exchange, Royal Gold pays far below market rates for the gold it receives (around $400 an ounce), leading to massive margins.
The remaining miners – Newmont, Yamana, McEwen, and IAMGOLD – also have positives working in their favor.
Newmont Mining, one of the world's biggest mining companies, managed to grow its cash flow from continuing operations by 77% during Q2 2016 from the prior-year period to $780 million, all while its gold AISC fell by $33 an ounce to $876. As a refresher, Newmont mines more than just gold, with its byproduct metals helping to offset its gold-mining costs. Investors have to be happy as well that its Merian, Long Canyon, and Tanami projects are on schedule and at or below budget.
Yamana Gold actually reported a 12% increase in its AISC in the second quarter, but it has a very good reason for rising costs. Yamana's recent acquisition of Carpathian Gold's Riacho dos Machados mine could add up to 100,000 ounces of gold production annually by 2017, and it's been investing heavily in developing both Cerro Moro and C1 Santa Luz with the expectation of commissioning both mines in early to-mid 2018. Yamana already uses its copper production as a byproduct to lower its AISC, and now it sits on the precipice of a major production expansion.
McEwen Mining, a gold and silver miner, delivered substantial AISC improvements in Q2 2016 from the previous year with AISC dropping about 10% to $942 an ounce. Tight cost controls have been pivotal to its turnaround, but it also helps that the company has no debt. Looking ahead, the improved prices for physical gold could result in its advanced-stage Gold Bar project paying back its development costs in just two years with an estimated $31.5 million in average annual cash flow expected.
Last, but not least, IAMGOLD delivered slightly higher Q2 2016 AISC from the prior-year period, but roughly flat through the first-half of the year. Miners operating in Africa typically have higher labor costs, so this isn't a huge surprise for investors. What is pleasing is the 36% increase in gold margins and, more importantly, the underground ramp-up at Westwood remains on track and on budget. IAMGOLD may not be the most fundamentally attractive of this group of miners, but even it's on track to improve its operating results pretty significantly in the coming years.
If you've been eagerly waiting for a pullback in gold-mining stocks, this looks like a prime opportunity to consider buying.