What will Q2 hold for large-cap gold?

The biggest issue is cost control, analysts say.

By Minyanville.com Mar 22, 2013 4:29PM
The first quarter has not been kind to  Barrick Gold (ABX), Kinross Gold (KGC) and Goldcorp (GG), whose share prices have each shed more than 20%. All three large cap gold miners are hovering near their 52-week lows, with Barrick and Kinross each down around 18% year to date, while Goldcorp has fallen 11%.

At the same time, the SPDR Gold Trust ETF (GLD) is down just over 4% so far this year.
Looking ahead to the second quarter and beyond, Joung Park, basic materials equity analyst at Morningstar, says it will be difficult for large cap gold miners to perform well this year if gold prices don’t cooperate. With gold prices no longer rising, he says, controlling costs is now the single biggest issue for gold miners to tackle.
“Controlling costs for both production and new mine construction is a must if gold miners can hope to outperform bullion; however, very few of the large cap miners have been able to demonstrate such an ability thus far,” he says.
Still, a couple of large cap gold miners have recently emphasized that controlling costs is top priority.
With the release of the company’s 2012 results in February, Barrick president and chief executive Jamie Sokalsky noted that “rising costs, poor capital allocation, and the pursuit of production growth at any cost in the industry have led to declining equity valuations across the sector. The message is clear: the industry must chart a new path forward.”
Barrick, he explained, is increasingly re-focusing its business “based on the principle that returns will drive production, production will not drive returns." Some of these steps include cutting or deferring around $4 billion in previously budgeted capital spending,  and making no plans to build any new mines.
Kinross CEO J. Paul Rollinson also noted in February that the company’s planning and outlook for this year reflects a “continued focus on cost control, margin improvement, and free cash flow” -- and that the company is “pursuing every opportunity for cost reduction.”
Meanwhile, Canada’s Financial Post reported that Goldcorp is not changing its strategy. At this year’s PDAC conference, CEO Chuck Jeannes reportedly noted that, as other miners cut back, he expects to have more opportunities to do deals.

In addition to cost control, Park points to other challenges for miners, such as limiting capital spending inflation and trying to reward shareholders through higher dividends -- after the “punishment” he says they took the last few years by investing in gold miners instead of gold.
“You have to give investors a reason to get exposure to gold by holding gold mining shares instead of just buying the gold ETFs,” he says.
Similarly, Kenneth Hoffman, sector head, global metals & mining research with Bloomberg Industries, tells Minyanville while mining companies have seen the value of their equity plummet, despite flat-to-rising prices of the metals they mine, sharply rising costs are only one part of the poor performance puzzle.
“Obviously after $50+ billion (USD) in write downs and a historic purging of mining company CEOs, there is a valuation issue with companies," he says. "But I believe an even bigger culprit is the $250 billion ETF gold market, and the well over $300 billion global metal ETF market."

Investors, explains Hoffman, have flocked to these instruments at the expense of direct investments to the miners themselves.
As for the performance of the sector moving forward, Hoffman says this will depend upon the miners’ ability to finally deliver lower costs, cut back on the asset write downs and deliver earnings in a way that hasn't been allowed, so far, by this bull market in gold.
“Note that a number of seniors have announced a clearer 'all in cost' figure that better calculates their 'true costs,'" he says. "We hope this becomes an industry standard."
“Once costs are understood, then companies can focus on true cost reduction, not these mega projects that always seem to go awry,” he adds.
More from Minyanville

Mar 23, 2013 1:14AM
If gold miners can eliminated the constant write downs of bad investments then their cost of production can be held to $500-1000 per ounce and that's fine for a $1600 per ounce commodity. If gold were to fall to $1200 then miners better have a plan B, if it rises to $2000 then investors better have a plan B.
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