Gold miners can dig out of this hole

The overly battered sector is slowly lumbering toward a turnaround.

By InvestorPlace May 15, 2013 3:26PM

 Gold Bars copyright Stockbyte, SuperStockBy Aaron Levitt


iplogoIt's no secret at this point that gold miners are going through a rough patch.


After the precious metal's recent routing, firms that dig it out of the ground have fallen by the wayside, and they continue to drift lower as labor issues and political problems have raised production costs to reduce margins. 


Some smaller miners have even crossed the critical "marginal cost of production" line, deeming many projects unprofitable.


Given the various headwinds, it's easy to see why the inverse Direxion Daily Gold Miners Bear 3X Shares (DUST) -- which basically shorts the sector, with some leverage -- has been one of the best-performing investments of 2013.


Yet, given just how hated the gold miners are, you have wonder if the risk/reward spectrum is starting to move into investor's favor.


After all, sometimes the best time to buy stocks is when nobody wants them.


The trio of woes still persist

As we reported before on InvestorPlace, miners are really starting to feel the pinch with regards to costs across several fronts. Many gold mining firms have experienced surging energy costs over the last few years -- to the tune of 500% for diesel fuel and 20% for electricity. Meanwhile, wages for mine labor, higher royalty rates and growing resource nationalization have also put the crimp on vital margins.


With spot gold prices now sitting in the $1,400 per ounce range, profitability at several of these firms have been absolutely destroyed. A prime example is industry stalwart Newmont Mining (NEM). At the end of April, the mega-miner reported that earnings per share were 31% lower than they were in the year-ago period. As such, shares of the gold miner now sit at four-year lows as investors have run for the hills.


… but there is hope

Now that an industry leader is beginning to struggle (and as long as it's clear that other miners are struggling similarly), why would anyone want to place their bets on the wounded sector?


It all comes down to cost controls and production stoppages.


Given that margins continue to be depressed, it seems like many in the gold mining industry are taking their cues from America's natural gas producers (see InvestorPlace). As hydraulic fracturing took hold across the nation, prices for the fuel plummeted last year and reached historic lows. When natural gas crossed below the $2 per MMBtu threshold, many producers were met with unprofitable wells. So what did they do? They stopped producing natural gas, idled wells and moved on to producing natural gas liquids and shale oil. Those efforts worked, and in time, prices for natural gas have risen.


Now, it looks like many of the gold miners are doing the same thing. Already, some have announced plans to review their operations in light of these narrowed margins. Both Australian-based Newcrest Mining (NCMGY) and Silver Lake Resources (SVLKF) have put forth strategies to rein in production at several of their operations, while South Africa's Gold Fields (GFI) has announced plans to cut capex spending on exploration, according to BDlive. Analysts expect that other miners -- both large and small -- will follow these firms' lead and cut production at high cost mines over the next few months.


It stands to reason that falling global gold production will eventually drive up prices for the metal in the face of a rising demand picture. While many institutional investors have stopped buying gold, central bank buying hasn't budged an inch. As nations like China, India and Russia (see InvestorPlace) have sought to diversify away from dollar- and euro-denominated assets, central bank gold buying has reached 50-year highs, according to the World Gold Council. It's silly to think that China isn't or won't be "loading up the truck" if gold prices fall any more.


Then there is the sector's "cheapness" to consider. The decline in metals and mining stocks has pushed their valuations down to attractive levels. After falling from a peak of 29.3 times estimated earnings back in September 2009, the MSCI World Materials Index currently can be had for a mere 14.1 multiple -- just under 14.5 for the broader MSCI World Index. Meanwhile, gold is nowhere near as cheap as it was back in 2009.


Time to buy?

As we've seen with the natural gas producers -- and are starting to see with some of the coal miners -- production cuts do help raise prices over time. And just like the natural gas producers and coal miners, the gold industry is going go through some pretty nasty growing pains over the next year or so. Remember that value investing is called time arbitrage for a reason.


Smaller junior miners could see themselves in pretty hot water as analysts at Canaccord Genuity estimate that more than 575 junior mining companies have less than $500,000 in cash and equivalents, according to their last reported balance sheets, as reported by the Financial Post. That means if you want to play the potential value in the miners, you need to think big. We’re talking the Barricks (ABX), Newmonts and Goldcorps (GG) of the world as the potential shake-out starts.


Or better yet, since the NYSEArca Gold Bugs index -- which tracks more than a dozen of the world's largest gold companies -- is down roughly 35% year-to-date, a bet on the popular Market Vectors Gold Miners ETF (GDX) might be in order.


Just keep in mind that we're in the first inning of a long ballgame, and it could take a while for this all to pan out. But if you have some free capital and are willing to take a longer-term view, the hated large-cap gold miners could be a bargain.


As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.


More from InvestorPlace

3Comments
May 15, 2013 4:01PM
avatar

isn't true "investing" done only over the long-term.  traders are long gone.  savers were never in.  people who thought they were investors but couldn't take the short-term price declines had fled.

 

true long-term investors understand that re-inflation is coming down the road, that gold has intrinsic value built over thousands of years, that gold is rare and can only be mined and that sovereign nations will be forced to buy more and more fold to give their fiat currencies some semblance of reality, e.g. china has no cred on the street as a default currency due to its abysmal gold holdings compared to numero uno US holdings.

 

now we are not backing up the truck yet, but we are auto-rebalancing to accumulate shares.  no pain, no gain ... 

May 15, 2013 6:48PM
avatar

"After all, sometimes the best time to buy stocks is when nobody wants them."

 

Duh, that sounds like one of Buffet's herding quotes. I'd say ABX is a good bet since it's down over 50% and all the bad news is almost baked in unless the price gold goes much lower. Barrick has two properties, one in Argentina/Chile and the other in Dominican, that could product 1-2 million ounces of gold a year at less than $900 per ounce all in costs. I know Chile stop development on their side but that only looks like 4-6 months and $30 million more in envio costs.

May 15, 2013 4:27PM
avatar

That's what I'm kinda thinking; But I don't have no stinkin' Auto-rebalancing...I have to do it myself.

And these friggin Gold shares had better start improving...

I told myself a year/two ago to stop accumulating...Didn't want what we use to....Didn't stop.

But we only have about half as much, and we shall see.??

Report
Please help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease use this form to notify the moderators. They will investigate your report and take appropriate action. If necessary, they report all illegal activity to the proper authorities.
Categories
100 character limit
Are you sure you want to delete this comment?

DATA PROVIDERS

Copyright © 2014 Microsoft. All rights reserved.

Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.

STOCK SCOUTER

StockScouter rates stocks from 1 to 10, with 10 being the best, using a system of advanced mathematics to determine a stock's expected risk and return. Ratings are displayed on a bell curve, meaning there will be fewer ratings of 1 and 10 and far more of 4 through 7.

105
105 rated 1
271
271 rated 2
420
420 rated 3
633
633 rated 4
492
492 rated 5
532
532 rated 6
725
725 rated 7
515
515 rated 8
343
343 rated 9
140
140 rated 10
12345678910

Top Picks

SYMBOLNAMERATING
UPLULTRA PETROLEUM Corp10
EOGEOG RESOURCES Inc10
SWNSOUTHWESTERN ENERGY COMPANY10
TAT&T Inc9
COPCONOCOPHILLIPS9
More

VIDEO ON MSN MONEY

ABOUT

Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.

Contributors include professional investors and journalists affiliated with MSN Money.

Follow us on Twitter @topstocksmsn.