Is the gold market broken? While the demand for physical gold continues to rise and supply keeps falling, the freely traded price of gold continues to slide. With this being the case, it would seem as if the gold market is heading for a sudden correction, making low-cost miners with strong balance sheets, like Alamos Gold (NYSE:AGI), New Gold (NYSEMKT:NGD), and industry leader Goldcorp (NYSE:GG), look attractive.
Demand exceeds supply
Currently, I'm not much of a gold bull, however developments in the gold market are starting to make me think otherwise. Firstly, gold stored at COMEX, the leading bullion storage house for futures traders has reached such a low level that there are now over 110 owners per physical ounce of gold stored in COMEX's vaults. Now, I should mention that this figure includes paper claims to gold, like derivative contracts, but the figure is still significant.
Secondly, there are huge amounts of physical gold flowing into China through Hong Kong and Shanghai. This is nothing new, but the volume of gold flowing into China has reached record highs in recent months. There is also a 500-tonne gap in China's gold consumption data -- that's right, 500 tonnes of gold has gone missing. In dollar terms, that translates into about $23 billion of gold. There is speculation that the Chinese central bank has been swallowing excess demand , panic buying and stockpiling.
Lastly, the two points above have led to Ed Moy, chief strategist at Morgan Gold, making to following statements in an interview:
Ed Moy: "Quantitative easing has had a distorting effect on the price of gold...the West looks at gold, and they have been investing in a lot of electronic derivatives and proxies for gold...the East has been buying a lot of physical gold. That demand has actually gone up. China looks like it bought 1,000 tonnes in 2013 making them the number one buyer in the world."
Interviewer: "Do you have a concern about a possible gold shortage?"
Ed Moy: "Absolutely!"
So all in all, there is a compelling argument to suggest that the world is running out of gold, but prices don't seem to reflect this.
With this in mind, I'm looking to invest in the gold mining sector, but to limit my risk I'm only looking for low-cost producers that have high-quality assets.
Short-term pain, long-term gain
Alamos Gold is one of the more interesting gold miners. The company owns and runs the Mulatos gold mine in Mexico, one of the lowest-cost gold mines in the world. In fact, Alamos is producing at Mulatos for an all-in sustaining cost of $800 per ounce of gold produced, which means the company is highly cash generative. Cash and short-term equivalents came to $437 million in at the end of the fiscal third quarter, around 38% of the company's current market capitalization.
However, over the next year Alamos' production volume is expected to fall by around 30,000 ounces, and the company's AISC is expect to rise to just under $1,000 per ounce. Nonetheless, this slide in production volumes and rise in costs is only short term as the company transitions from open pit to underground mining for a higher quality of gold ore. Production is expected to rise back to 200,000 ounces per year during 2016.
All in all, Alamos recons that it has 6.6 million ounces of gold in reserve and nearly 36 million ounces of silver. To put this in some perspective, with gold currently trading at $1,260 per oz and silver trading at around $20 per ounce, Alamos' reserves are worth an estimated $9 billion, compared to the company's current market cap of $1.15 billion.
Small company, big ambitions
New Gold is yet another small-cap gold miner with attractive qualities. New Gold has not released a fourth quarter update yet, but its third quarter numbers are extremely compelling. Indeed, during the third quarter the company's AISC of gold produced was $779 per ounce, or $280 per ounce on a cash basis, this was down from $433 per ounce during the same period last year. New Gold has $429 million of cash and equivalents, long-term debt of $860 million and recently completed a takeover of Rainy River Resources, increasing the company's per-share gold reserves by 44%. That being said, due a lower projected production guidance for 2014, New Gold's AISC per ounce of gold is expected to rise to approximately $900 this year, although, New Gold's balance sheet remains robust and the company is generating around $50 million of cash per quarter with its low cost of production.
For the risk averse
Alamos and New Gold are relatively small companies, so they may not be suitable for everyone. One of the larger miners that looks attractive is Goldcorp, which recently released impressive production guidance for 2014. Goldcorp is predicting that its AISC of production per gold ounce will drop to $950 to $1,000 during 2014; gold production is also expected to increase around 15% for the year. Further, Goldcorp recently sold its holding in the Marigold mine, which was jointly owned with Barrick Gold and had a high AISC of over $1,400 per ounce. Goldcorp expects costs to drop following this divestment and will update the market once the deal is closed in April. With Goldcorp's production ramp-up and costs falling, it's easy to see why the company has surpassed Barrick as the largest gold miner by market capitalization in the world.
It would appear that the gold market is broken and could be due for a correction. With that being the case, investors who want to take a position should look to miners with a low cost of production and strong balance sheet like those above.