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Don't Overreact to Fear of a Chinese Economic Slowdown

By Bob Ciura – Mar 15, 2014 at 1:15PM

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Investors are selling off precious metals mining stocks in the aftermath of disappointing Chinese exports. But the market seems to be missing the long-term production growth prospects of Barrick Gold, Freeport-McMoRan, and Southern Copper.

Just when precious metals miners Freeport-McMoRan Copper & Gold (FCX 2.79%) and Southern Copper (SCCO 2.60%) seemed to have the wind at their backs, due to a much-needed recovery in gold and copper prices, the wind may be out of their sails once again. That's because economic data from China has renewed concerns of a Chinese slowdown. Fears of falling demand for precious metals in China are rising once again, disappointing those who were hoping that Freeport-McMoRan and Southern Copper may finally be out of the woods.

Short-term traders may be concerned by the sell-off in precious metals stocks on the day of the economic data release out of China. Despite this discouraging data, there's still a long-term investment argument for gold and copper miners.

Miners took in on the chin in 2013
China's exports plummeted 18% in February, falling to the lowest level since August. This sent stock prices of materials companies down across the board, since the market is now concerned that demand for commodities will turn south. This couldn't come at a worse time for precious metals miners, which are already reeling from the collapse in gold and copper prices last year.

As gold and copper prices fell last year, so did the financial fortunes of many precious metals miners. Consider that Barrick Gold (GOLD -0.64%) lost a whopping $10.37 billion in 2013. To a significant degree, this was due to declining average realized prices for gold and copper. Indeed, Barrick's average realized gold price fell 16% in 2013.

However, it seems that at their core, precious metals miners aren't performing as poorly as it seems. Barrick's results last year were affected most by a huge after-tax impairment charge of $11.54 billion. Stripping this out reveals that Barrick actually produced an adjusted profit of $2.57 billion in 2013. This may be a better view of Barrick's true underlying business, since it adjusts for non-recurring items. During the year, Barrick took charges for suspending construction of its Pascua-Lama project, and reduced the estimated life of its Porgera mine.

It seems Barrick's core business performed decently well, especially considering what a brutal environment for miners last year amounted to. For instance, Barrick generated $4.24 billion in operating cash flow. In addition, Barrick strengthened its balance sheet by reducing operating and capital costs by $2 billion last year. As a result, there are signals that its true underlying operations are sound.

Why the pain may be priced in
Another reason for optimism is that certain miners, like Freeport-McMoRan and Southern Copper, kept production strong last year. That should make a recovery even more substantial if, and when, precious metals prices recover. To emphasize, consider that Freeport grew copper and gold production last year by 13% and 30%, respectively, in 2013.

For its part, Southern Copper's production held up decently. Overall production dipped just 2% last year, but increased 1% in the fourth quarter. And, the company made significant progress in its key Buenavista projects in Mexico, which will drive further production growth up ahead.

The project is almost 70% complete and should be finished in the first half of 2015. Annual production capacity is an impressive 188,000 tons of copper. This would represent significant growth since Southern Copper produced a grand total of 637,000 tons of copper in 2013. In percentage terms, the Buenavista projects stand to boost annual production by nearly 30%.

Recent actions signal that management teams of Barrick Gold, Freeport-McMoRan, and Southern Copper are confident in a recovery sooner rather than later. Barrick has restructured its financial position and generated solid cash flow last year. At the same time, Freeport and Southern Copper are proceeding with business as usual, and effectively ignoring the downturn in precious metals prices over the past year by increasing production in the years ahead. It seems the market panicking over one disappointing economic data point out of China seems short-sighted.

Bob Ciura has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. 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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