Turbulent times in the gold sector

Investors are worried about Barrick Gold and Yamana Gold. The precious metal overall doesn't seem ripe for a rally anytime soon.

By Jim J. Jubak Nov 5, 2013 9:30AM
Image: Small Stack of gold ingots (© Anthony Bradshaw/Photographer)Barrick Gold (ABX) freaked out the gold sector on Nov. 1 with news that it would raise at least $3 billion in a new stock offering.

At a minimum of 163.5 million shares, the offering represents 16% dilution for current shareholders. (Earnings would have to be spread over 16% more shares.)

And that has raised fears across the sector as traders and investors try to figure out which company might be next. Of course, as is usual, the initial reaction is to sell first and figure out the danger to any specific company later. 

Shares of Barrick Gold fell 11.2% on Nov. 1. Want an example of collateral damage? Shares of Yamana Gold (AUY) dropped 5.6% on the day. (Yamana Gold is a member of my Jubak’s Picks portfolio.)

Here’s the problem at Barrick Gold in a cash flow nutshell. With the drop in the price of gold, Barrick’s revenue has tumbled and that has put a big strain on cash flow. The company finished the September quarter with $2.28 billion in cash and cash flow from operations of $1.23 billion. 

But because Barrick has such a big investment program, that operating cash flow turns into just $26 million in free cash flow. And that’s after cutting dividend payments in the quarter to $50 million from $200 million and reducing capital spending to $1.21 billion from $1.56 billion.

Without those reductions Barrick Gold would have been free cash flow negative for the September quarter.

That left CEP Jamie Sokalsky with just a few options.

The company could further cut capital spending by suspending construction at projects such as the Pasua-Lama mine n the Argentina-Chile border. Barrick announced that it would do just that at the same time as it announced its stock offering. Cutting capital spending, however, is a tricky game since it does delay future revenue gains even if it saves money now.

Barrick could sell assets -- but with the price of gold and copper assets so low, this assures that assures that the company sells on the cheap.

Or the company could bite the bullet and sell stock.

Beyond the effects at Barrick, the stock sale raised worries across the sector that 1) Barrick was expecting gold prices to fall even further, and that 2) other gold miners will have to sell stock and dilute current shareholders.

I can’t predict the price of gold from here. With the U.S. and global economies showing signs of weakness I think you can certainly make an argument that gold isn’t a good candidate for a rally from here in the coming months.

I think you can get a handle on the dangers of dilution, however, at any company by taking a long look at cash flow. The picture isn’t pretty even at the strongest companies in the sector. 

At Yamana, for example, cash flow from operations of $99 million in the September quarter turned into negative free cash flow of $119 for the period. The company hasn’t yet reduced dividends but that seems quite possible in coming quarters. Yamana has cut capital expenditures to $218 million from $301 million, though.

In its conference call, Yamana said that it projected that the fourth quarter represented the end of a capital spending “bulge.” Add that to an expected increase in gold production and improving margins and the company projected that its cash position would bottom in the fourth quarter and then begin to improve.

The question, of course, is whether or not you believe that projection. Yamana is forecasting that gold prices will be flat in 2014. That would be good news for the company’s cash flow since I’d assume that given its current cost cutting record Yamana could grow cash flow if gold prices stayed steady.

Why do I think that’s possible? From the second quarter of 2013 to the third quarter, Yamana was able to increase cash flow per share by 20%--from 20 cents a share to 24 cents a share by cutting costs and by shifting production to higher margin mines from lower margin mines.

I think this all means that investors in Yamana have a good chance of escaping the dilution that Barrick just delivered to its shareholders.

That isn’t a lock, of course. And these certainly aren’t great times in the gold sector. If, however, I could get a chance to buy Yamana Gold at $9 or less because of troubles at its sector peers, I think the risk would be more than repaid by the potential reward.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. When in 2010 he started the mutual fund he manages, Jubak Global Equity Fund (JUBAX), he liquidated all his individual stock holdings and put the money into the fund. The fund may or may not own positions in any stock mentioned. The fund did own shares of Yamana Gold as of the end of June. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here

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23Comments
Nov 5, 2013 4:07PM
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When the fiat US dollar tanks....which it will due to the continuing infusions of toilet paper Benny Bucks

(to superseded by Yellen Yen) and there is nothing of real value in the world in which to 'invest', gold will reign supreme as it always has through out history. I'm speaking of actual physical gold that actually have in your possession, not this phony paper futures junk. If you can't touch your gold, you don't have any.

Nov 5, 2013 5:04PM
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Here are some good investments I've found in an uncertain economy:  1) home improvements for energy efficiency and renewable energy.  A high performance home will be  a good investment for decades and has low operating costs;  2)  a high mpg low cost car (think 2002 Geo Prizm). Affordable transpotation is a great investment;  3) membership in my local food coop and a share in a local CSA (community supported agriculture farm).  Investing in my regional farm economy and food system builds my local economy, gives me healthy food and builds food security for the region; 4) Local taxes - provide me with great community services -- library, gym, community theater, senior center, community center, roads and snow plowing and more;  5) State taxes -- among many other things, funds the community college system, which proveds me with employment and offers workforce training programs that help unemployed workers re-skill for in-demand careers (advanced manufacturing, health care, clean energy, info tech and more).  Those kinds of investments help hold together a functioning society and keep us from the threat of collaps that makes some people want to invest in guns and gold.  Find ways to invest in your home, your health and your community.  It will make you happy and more secure even if it doesn't make you rich.
Nov 5, 2013 4:17PM
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Its not easy to find gold in the ground these days,  it takes a huge amount of capital to explore for viable veins.  Generally these deposits are in remote areas and difficult to get the right equipment to explore.  With the ever increasing regulation for environmental compliance, deposits have to provide at least a 25 year reserve before making the investment to mine the area. 
Nov 5, 2013 4:54PM
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Mmmm....lets see fuel costs, equipment repair and replacement, lease and royalty costs and the biggie...they have employees = payroll costs that continue to rise (hint-health care and workmans comp)
Nov 5, 2013 5:25PM
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I just bout a 1887 gold coin that weighed a few grams and I paid $300, its face value is $1.00. Should I go buy a candy bar with it? No... I think I will hold on to it.
Nov 5, 2013 10:31AM
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My question is when are we going to start making money again in Gold and Silver...

 

It's been quite a long time now...

As far as mining companies selling, follow on offerings to raise cash and/or only dilute their stock...

Maybe they should work a little harder at getting gold out of the ground, find better mines or cut their "all in" costs..?? 

Nov 5, 2013 4:21PM
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In the not too long term, the only things that will have any real value will be guns and ammo!!

We are living in an artificially subsidized economy (Benny B. Bucks) that will have to fail.

 

Gold, like all other commodities only have value if there is a use for them. No food and a gold necklace just doesn't work in the real world.

Nov 5, 2013 4:44PM
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quality companies are your best bet, that and real estate (long term)

 

Gold is not an investment.

Nov 5, 2013 4:32PM
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MIKE P:Is it fun missing out on 90% gains in the market just because you weren`t smart

enough to buy stocks when Obama took office?Stupid is forever !

Nov 5, 2013 4:37PM
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It seems to me that gold is a great investment if you are trying to over time make a profit.

If you are buying it to survive global monetary armeggedon it does not seem to hold water.

I cannot see a person with a vast amount of gold going to the grocery store and handing an ingot for some food.

I can see a person getting their ingots taken away from them when people trying to survive find out you have them.

And no, you don't have enough guns to stop them no matter what you think.

Nov 5, 2013 3:26PM
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You notice gold lovers are leech Republicans that aren't smart enough to buy stocks ?
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