An investment in Newmont Mining Corp. (NEM 1.88%), as in any other company, carries some degree of risk. With great risk can come great reward, though, so let's look at the three greatest risks facing this gold mining leader.
Aye-Aye, Captain Obvious
Whether one chooses to buy gold coins, shares of a gold ETF, or stock in a gold-mining company, all gold investments bear the same risk: volatility in the market price of gold. And there's no shortage of factors that people believe influence the price of gold. In the company's 10-K, Newmont's management presents a non-exhaustive list of 13 factors, which it recognizes as variables influencing the price of gold.
Oftentimes, a decline in the price of gold adversely affects revenue, net income, and operating cash flow. For example, in 2015, gold sales decreased $118 million compared with 2014, in part because the average net realized price of gold fell $117 per ounce.
But the deleterious effects can reach much further -- beyond the financial statement and into the company's pipeline. From identifying a gold deposit to operating a mine that's producing gold, there are several steps, which often take many years.
One of Newmont's strengths is that it has a healthy pipeline of projects at varying stages of development, positioning the company nicely for future success. According to management, should the price of gold decline too much, it may be required to "halt or delay the development of new projects," as well as "reduce funds available for exploration and advanced projects."
Fill 'er up
Once Newmont digs gold out of the ground, it must make sure it has a new direction where it can point its drills, but this isn't a simple task. Like the volatility in the price of gold, the company's inability to continually replace its gold reserves is a conspicuous risk. As the company states in the 10-K, it must "continually replace reserves depleted by production to maintain production levels over the long term and provide a return on invested capital." During 2015, for example, Newmont reduced its proven and probable reserves by 5.1 million ounces.
There are several ways in which the company can replace its reserves. For one, it can expand production at known ore bodies -- something the company is currently pursuing at its Tanami mine in Australia. Tanami produced 436,000 ounces of gold at an all-in sustaining cost (AISC) of $724 per ounce in 2015. Once the expansion is complete and production begins, management forecasts, on average over the first full five years, for Tanami to produce between 425,000 and 475,000 ounces at an AISC approximately $50 per ounce lower than the $724 per ounce it reported in 2015.
Besides expanding production, the company can also replace its reserves by finding new deposits; however, this is easier said than done, and many times exploration activities don't lead to the identification of new deposits. Even if a new deposit is located, though, it doesn't mean the company's reserves will be replaced anytime soon.
It can take 10 years or more before the site begins the commercial production of gold. And don't forget how the volatility in the price of gold compounds the risk.
A third option is to replace its reserves through acquisitions -- something Newmont did in 2015, when it acquired the Cripple Creek and Victor gold-mining business from AngloGold Ashanti for $821 million. Replacing reserves through acquisitions, however, is not a solution to which management often turns.
Digging into costs
Once again, from the 10-K, we find the most generic of statements: "Our operations are subject to risks of doing business." Thankfully, management narrows this generality down further: "Exploration, development, production, and mine closure activities are subject to regional, political, economic, community, and other risks of doing business."
Having seen these generic "risks of doing business" come into better focus, let's see how they've recently manifested themselves to better understand Newmont's position.
Political risk, for one, is something with which Newmont is quite familiar. Beginning in 2014, the Indonesian government issued new regulations that made it harder for Newmont to obtain the requisite export permits; consequently, Newmont shut down operations at its Batu Hijau mine because of an inability to export and sell its copper concentrates. Several months later, though, after agreeing to pay higher royalties and export duties, Newmont resumed operations.
Although the strained relations with the Indonesian government related to copper -- not gold -- the Batu Hijau mine still represented a significant source of value. In 2015, the mine produced 676,000 ounces of gold, which meant that Indonesia accounted for 21% of Newmont's revenue that year. Despite these figures, management recognized that the risk was too great, and this past June, Newmont announced that it had entered into an agreement to sell its interest in the Batu Hijau copper and gold mines.
Indonesia isn't the only area where political risk rears its ugly head. Following local political and community protests, Newmont suspended construction operations at its Conga Project in Peru -- a site of 6.5 million attributable ounces of gold reserves -- at the request of the country's central government in November 2011. And there doesn't seem to be a silver lining to this cloud. Management makes clear in the 10-K that "under the current social and political environment, the company does not anticipate being able to develop Conga for the foreseeable future."
When considering mining stocks, investors must recognize the various ways in which market volatility can affect the company and its operations. A significant drop in the price of gold could severely hamper the company's ability to sustain operations at a given project, forcing management to shut down the project and possibly incur significant losses.
And although political and social risks are relevant to nearly every business, mining companies are especially sensitive to them -- something Newmont knows well from its dealings with Batu Hijau and Conga. But the discussion of the risks facing Newmont Mining isn't meant to dissuade investors from considering a position -- merely to educate them. After all, the best type of investor is an informed investor.