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Will Yamana Gold Inc's Bet on Argentina Pay Off?

By Vladimir Zernov - Feb 27, 2014 at 2:39PM

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Yamana Gold plans to invest in two mines in Argentina despite the difficult economic situation in the country.

Right now, Argentina is suffering from the devaluation of its currency, high inflation, and rising unemployment. However, Yamana Gold (AUY -3.29%) sees an opportunity in these developments, as the company focuses on developing two mines in Argentina – Cerro Moro and Suyai. The mines look promising, but is it a wise move given the worrying situation in the country?

High grades offset uncertainty in Yamana Gold's view
Currently, Yamana Gold has one producing mine in Argentina – the Gualcamayo mine. The company also holds a 12.5% interest in the Alumbrera mine, which is operated by Xstrata. This mine produced 120,000 ounces of gold in 2013, roughly 10% of the company's total production. This year, Gualcamayo is expected to increase production to 170,000 ounces.

Gualcamayo produced 1.61 grams of gold per ton of processed ore in the fourth quarter of 2013. In comparison, Cerro Moro's grade is estimated to be 24.34 grams per ton, while Suyai's grade is estimated to be 15.6 grams per ton. High grade leads to lower costs, all else being equal. This is why Yamana Gold is willing to invest money in Argentina during the tough times.

On the contrary, some companies like Silver Standard Resources (NASDAQ: SSRI) prefer to diversify from the country. Silver Standard's only producing mine, Pirquitas, is in Argentina. The company recently announced that it is going to acquire Marigold mine from Goldcorp and Barrick Gold in a move to get immediate production in a safe jurisdiction.

Bringing cash to the balance sheet to support future projects
Cerro Moro is expected to deliver first production in 2016. The mine will be producing 150,000 ounces of gold annually and needs $150 million in capital expenditures. As for Suyai, Yamana Gold plans to apply for environmental permits this year. The company estimates that it will need $220 million to develop the project, which will bring 150,000 ounces of gold annually.

In anticipation of these expenses, Yamana Gold has cut its 2014 capital budget by 54% and has also cut its dividend. The company stated that it wants to use the extra cash to strengthen its balance sheet. This cash could be used for taking other opportunities in Argentina rather than for debt repayment.

The capital spending cuts are happening across the industry this year as the gold price remains below levels desired by miners. For example, AngloGold Ashanti (AU -2.41%) cut its capital budget to $1.3 billion-$1.45 billion from $2 billion in 2013. AngloGold was investing heavily in the recent years. As a result, AngloGold achieved its first annual production growth since 2005, but continued to see net cash outflows. This year, the company will be focused on achieving positive net cash flow, just like Yamana Gold.

As Yamana Gold increases production while cutting spending, its cash flow is likely to improve. The company reported that it estimates all-in sustaining costs of $925 per ounce this year. This cost level makes Yamana Gold one of the lowest-cost producers on the market, giving the company a safety cushion in case gold prices deteriorate.

Bottom line
Yamana's decision to dedicate growth capital to Argentina looks like an interesting bet. The devaluation of the country's currency could help lower the labor costs. However, if the economic situation becomes worse, political stability could come under question. In my view, the game is worth the candles as high-grade mines promise a constant source of low-cost production in the future. 

 

Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

AngloGold Ashanti Limited Stock Quote
AngloGold Ashanti Limited
AU
$14.97 (-2.41%) $0.37
Yamana Gold Inc. Stock Quote
Yamana Gold Inc.
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$4.71 (-3.29%) $0.16

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