Gold has undergone big changes. Momentum investors have left the market and now jewelry purchases dominate gold demand. The downside is that jewelry demand does grow as quickly as investment demand. Gold has entered its own new normal, and it is time to stay away from high-cost miners with large debt.
The supply and demand situation
In the third quarter of 2013, jewelry demand accounted for a 56% of total gold demand while investment demand was just 21.3%. This is a big change from Q3 2012 when jewelry demand was just 41.9% of total demand and investment demand was 38.6%.
In the past 12 months, investment demand has fallen by 239.8 tonnes, but jewelry demand has only increased by 25 tonnes, or 5.4%. In the coming years jewelry demand will increase but by far less than the lost 239.8 tonnes of investment demand. Expect increases in jewelry demand of around 5% to 8% per year, in line with underlying GDP growth of big Asian consumers like India and China.
Remember that gold is promoted to investors as an inflation hedge, but inflation has fallen to unheard of levels at around 1% in the U.S. and Europe. These regions have huge swaths of their populations unemployed or underemployed, placing a lid on wages and inflation for years to come. For the foreseeable future, gold miners will be forced to rely on jewelry demand.
Be careful with gold miners
Buying a miner with high costs is a poor choice, and Gold Fields (ADR) (NYSE:GFI) is a prime example. In the third quarter of 2013, it posted all-in sustaining cash costs (AISC) of $1,089 per ounce. Seeing as the price of gold is below $1,300 per ounce, Gold Fields' cost structure is very high.
While the company is closing down its North Heap operations in its Tarkwa mine, with all-in heap leach costs of around $1,600 per ounce, it just purchased the Yilgarn South field with AISC of $1,145 per ounce in the first half of 2013. With this latest purchase its cost structure will still remain very close to the current gold price.
Gold Fields does not have a huge amount of debt, but it still has a total debt-to-equity ratio of around 0.4. Given its AISC of $1,089 per ounce and existing $2.1 billion in utilized debt and loan facilities, it is best to err on the side of caution.
Newmont Mining (NYSE:NEM) has brought AISC down to $993 per ounce. It has decreased its 2013 capital expenditure outlook by $400 million, and it sold off $587 million in non-core Canadian oil sands assets. It is important to watch the company's debt load. Its total debt-to-equity ratio is somewhat high at 0.6, but the majority of its debt will not need to be rolled over until 2019 or later.
At the end of the day, Newmont Mining shouldn't be ignored, but the company's costs are still on the higher side of the spectrum.
Goldcorp's (NYSE:GG) recent AISC came in at $992 per ounce, a big improvement from its Q2 2013 AISC of $1,279 per ounce. The good news is that the company has very little debt with a total debt-to-equity ratio of 0.1, and a number of mines like Alumbrera, Marlin, and Pueblo Viejo with Q3 2013 AISC well below $1,000 per ounce.
Investors in Goldcorp benefit from the company's size. The company is big enough that it can fund development from retained earnings. Its Cerro Negro project in Argentina should reach commercial production in Q4 2014, helping to boost its bottom line. While Goldcorp's costs could be lower, its low debt load paints the firm in a positive light.
Barrick Gold (NYSE:GOLD) has been a great bear play. It suspended construction on its Andean Pascua-Lama project, diluted existing shares with a $3 billion public share offering, and sold off assets to Gold Fields. Hopefully these decisions will help the business in the long run, even if they do hurt current shareholders.
Its current gold AISC of $916 per ounce is quite low, thanks in part to its partnership with Goldcorp in Pueblo Viejo. Barrick's all-in costs on a co-product basis are only a bit higher at $936 per ounce. Even with these low production costs, Barrick's debt and decreased growth prospects continue to overshadow the company. It is best to stay away from this miner for the time being.
Gold has entered a new period where demand is not growing by leaps and bounds. The lowest-cost miners are still worth your time, but be careful with high-cost producers like Gold Fields. Newmont Mining and Goldcorp come out in the middle of the cost structure. Over the coming year, it will be important to see if these companies can keep their costs down and maintain production levels. Barrick Gold is another story. Its debt load is so large that it is best to wait and see how things pan out.