Tag Archives: gold

gold mining stocks?

January 9, 2014 By in Gold, Industry Analysis, Mining, Portfolio management, Stock ideas Tags: , , , , , , 1 Comment

gold mining stocks

I spent part of the day yesterday looking at gold mining stocks.

the potential attraction?  …over two years of dreadful performance.

Since mid-2011, the gold price is down by about a third.  Over the same time span, many gold stocks have lost between half and three-quarters of their value.  And that’s during a period when the S&P is up by about 50%.

Sentiment about gold has also taken a decidedly negative turn.  Hedge fund managers are no longer bloviating (how about that word?) about the superiority of the yellow metal over “fiat money.”  Boiler rooms are no longer filling the airwaves their odd sales pitch that “Gold has tripled over the past five years.  (Therefore you should) buy some now!!”

In addition, I think that 2014 will be a year of consolidation for the S&P.  So a 3% dividend yield plus the chance of, say, a 15% gain looks to me to be substantially more attractive than it might have been a year or two ago.

my verdict

I’m not so interested, for two reasons:

1.  I think the gold price is still too high.  In the past, the gold price hasn’t bottomed until it reaches a level where at least some existing mines become uneconomical.  This means that the cash a company must spend (not including non-cash costs like depreciation) to produce an ounce of gold is greater than the selling price.  As best I can tell (a long time ago, I would have considered myself an expert, but I’m certainly not one now), that’s below $1,000 an ounce.  The price may never get there, but, as an investor, I’m looking for situations with more upside than downside.  I don’t see that here.

2.  I don’t think companies have completely stabilized themselves yet.  The industry took on a lot of debt to fund what have turned out to be ill-advised capacity expansions at the top of the market.  That’s par for the course.

As far as I can see, these projects have by and large been at least temporarily mothballed.  However, there’s still the debt to deal with.  It isn’t so much that there are borrowings on the balance sheet that bothers me.  It’s that financially leveraged firms have to continue to mine in order to repay their lenders.  So supply isn’t taken off the market as quickly as it might otherwise be.  A number of companies had stock offerings last year.  Good for them, but this just prolongs the adjustment period.

All in all, I don’t find the risk/reward to be favorable enough right now.  Maybe in six months.

 

 

 

 

where’s the bottom for the gold price?

July 8, 2013 By in cash flow/share vs. earnings/share, Current Market Thoughts, Gold, Industry Analysis, Mining, Stock ideas Tags: , , , , , , 4 Comments

falling gold

The gold price has fallen steadily from a high of just under $1800 an ounce last October to the current spot price of $1231 this morning.

How low can the gold price go from here?

supply/demand…

In the simplest terms, prices fall when producers supply more to the market than buyers want at a given price.  The price drops to the point where buyers are willing to absorb the excess supply.  Typically, producers read the market signal and begin to cut back on the amount they put on the market.  When cutbacks are large enough, the price stabilizes.

For most things, adjustment happens quickly.  For gold   …not so much.

…for gold

Gold is mined in remote, inhospitable places by hardy workers who operate expensive and highly specialized machinery that needs considerable maintenance.  Once a mine shuts down, chances are it won’t reopen.  It’s hard to reassemble the needed mining crews…and it’s expensive to bring the plant and equipment back up to snuff.  So mining companies try to avoid shutdown at all costs.

Part their planning tends to make over/undersupply worse rather than better.

As the gold price rises, mines continue to process the same amount of ore, but switch to lower-grade areas.  This means they produce less gold, increasing the supply squeeze.  Conversely, when prices being to fall–the situation we’re in now–mines routinely shift to processing higher-grade deposits.  The idea is to keep their revenue steady–and therefore the mining crew together and the mine profitable.  But putting more gold on the market tends to depress prices further.

waiting for the weak to falter

Experienced mining firms also know how any market downturn will play out, even if no one voluntarily withdraws supply from the market.  At some point, the gold price will drop below the cash outlays of the highest-cost mines.  When red ink causes enough of these to cease production, supply will shrink, restoring equilibrium.

So…

…the gold price bottom question boils down to what cash costs for gold miners are and at what price do high-cost gold mines begin to die.

the Thompson-Reuters report

On April 4th, Thompson Reuters issued its 2013 Gold Survey.

TR says current average cash costs for the gold mining industry are $738 an ounce.

Average cash costs in 2009 were well under $500 an ounce, suggesting that that price level is highly defensible.   The addition of high-cost South African supply (averaging over $1,000 an ounce) and cost increases in Australia (much of it currency-induced, I think) are responsible for most of the rise since.

my take

Relative to nine months ago, gold looks cheap.  But supply probably isn’t going to be withdrawn from the market until the gold price falls below $1,000.  And rock-bottom (sorry) is probably $600 or so.

That’s a long way down.

To my mind, no one other than dyed-in-the-wool gold bugs will be interested in gold today.

the FT’s “listen to gold” op-ed

May 22, 2013 By in Constructing a Portfolio, Current Market Thoughts, Gold, Portfolio management, Strategy Tags: , , , , , , , , , 3 Comments

The other day the Financial Times carried an op-ed column titled “We should listen to what gold is really telling us.”  It was written by regular contributor Mohamed El-Erian, the  marketing voice of bond fund giant, Pimco.

I usually skip over what Mr. El-Erian writes.  His prose style is weak and the solution to every economic or financial worry he discusses is to buy more bonds.  In this case, I made an exception.  I was curious to see whether Pimco would be in the old-school camp that says gold is money or whether, like me, Pimco would maintain that it’s an industrial metal that new mine development has put into chronic oversupply (just like in the 1980s).

The article isn’t really about gold, though.  It’s about the fact that when more money than is needed is sloshing around in the world economy–and central banks around the globe continue to print new money at a rapid rate–some (all?) of the excess finds its way into speculative investing.  Sometimes, according to Pimco, even though the overall speculative tide has not yet crested, some prices become so divorced from reality that localized bubbles still burst.  Three examples:  gold, AAPL and FB.

At this point in the article, I thought what would come next would be an assertion that these three are harbingers of the behavior of all sorts of financial investments once monetary stimulus starts to be withdrawn.  If so, I thought to myself, Pimco will have a hard time ducking the issue of the popping of the biggest bubble of them all, the bond market.

That’s not the tack Mr. El-Erian takes, though.

He asks what happens if all the global monetary stimulus fails to reignite economic growth.  Put in a different way, what happens if world economies begin to roll over and enter recession?  The money taps are already wide open, so there’s nothing central banks can do to cushion the fall.  Fiscal policy is the only tool available.  But that takes time to work–and requires well-functioning legislatures to understand what’s going on and act both appropriately and quickly.  Fat chance.

This is a really scary scenario.  There’s absolutely no current evidence I can see that it’s likely.  El-Erian just poses the question and doesn’t say what he thinks.

Still, from a financial planning perspective, it’s something we all have to consider and be on the alert for the signs of.  Of course, conveniently for Pimco, this is the only situation I can think of where it makes sense to be holding government bonds.

what do gold and AAPL have in common?

April 22, 2013 By in Gold, hedge funds, Recent Market Action, Stock ideas, Technology, Wireless Tags: , , , , , , , , 1 Comment

common factors

–they’re both large positive bets (large holdings) of hedge funds–and of many retail investors

–both have delivered weak performance over the past year, after extended periods of substantial gains.  And the losses have occurred during a time of generally stable conditions for the world economy, with ample liquidity and strong inflows of money into financial products

–recent trading in both seems to me to be giving signs of forced or distressed selling

are these factors connected?  

It’s hard to know, since global hedge fund disclosure is incomplete–and there’s ample evidence that what disclosure there is can’t be relied on.  However, I think it’s reasonable to assume they are.

if so, what does this imply?

In my experience, a professional investor goes through a three-step process as he realizes he’s made a mistake–or that his previously good idea is no longer working.  He:

–stops adding to the position when new money comes in, effectively shrinking its relative size,

–begins to sell, to further lessen the negative effect of the position on performance, and

–accelerates the selling when the position is small enough the extra visibility and extra downward pressure on price make little difference.

A professional investor can go through these states in the blink of an eye, or it can take a long period of time. A lot depends on style, self-awareness and how ugly the underperformance is.  Anyone who operates on margin may also get additional feedback from his lenders.

Many retail investors, in my experience, just panic–very close to the bottom.

Recent price action in gold and in AAPL strike me as Stage-Three end-game activity–some combination of panic, response to margin calls and/or dumping of the remainders of positions being sold over long periods.

is this an opportunity to buy?

gold: 

For me, the answer here is easy.  It’s “No.”  The key supply-demand issue is whether central banks in emerging markets will continue to buy gold in the aggressive way they have done over the past several years.  I have no idea.  So I’m clearly the “dumb money” in this arena–the strongest reason there is to stay away.

AAPL:

We’ll have more information tomorrow, after AAPL reports its latest quarterly earnings.

The stock is now trading at less than 9x historic earnings and yielding 2.7%.  The shares have underperformed the S&P 500 by more than 50 percentage points since last September.

The company has no debt and its cash holdings are approaching almost half the market cap.

If there’s anything “wrong” with the stock, it’s that its fall from grace has been so extreme.  That prompts the question, “What must sellers know that I don’t?”

How do you overcome aversion, based on an extended decline, to a stock that looks like a $100 bill lying on the street?  The first step, I think, is to look for signs that the waves of selling that have pummeled AAPL are over.   This means having AAPL announce bad news and have the stock go up, rather than sell of further.  That’s why tomorrow’s earnings report may be important.

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commodities cycles

April 18, 2013 By in Capital-intensive firms, Current Market Thoughts, Gold, Industry Analysis, Mining, Trading Tags: , , , , , , , , , 2 Comments

commodity rhythms

agricultural

The co-owner of one of the smaller investment companies I’ve worked for was a farmer.  He made me realize that there are no long cycles for most agricultural commodities.  If prices for a particular crop are high, farmers will plant more–usually a lot more–the following season.  That virtually guarantees that prices will either level out, or more likely fall.  The opposite happens–supply falls, and prices subsequently go up–if prices are currently low.

Considering that many crops have two or three growing seasons in a year, price adjustment comes swiftly.

metals

Metals mining, especially base metals mining, is just the opposite.  Mines tend to be gigantic projects, costing billions of dollars and designed to last 20 years or more.  Most of that money is spent up front:  for the mine itself, for all the drilling machines and other earth moving equipment, for the ore processing plants, for the roads or rails to tap into a country’s established transport infrastructure, and maybe even for new sources of electric power.

Because the optimal project size is “humongous,” mines tend to spew out very large amounts of output when they open.

Because–unless you’re very unlucky–the running costs are low relative to the initial investment, projects seldom shut down once they’re up and running.  They normally don’t even consider doing so unless the output price falls below out-of-pocket extraction costs.  And even then a mine may not shut down.  Miners always identify pockets of especially rich ore that they set aside for a rainy day.  So the first response to weak pricing it to turn to these high-grade areas in order to keep going–and spewing even more price-depressing output on the market.

In addition, some emerging countries run their mines to create employment and get foreign exchange.  Because whether they make money or not is a secondary concern, such mines almost never shut down.

The result of all this is a supply/demand dynamic somewhat like the farm one I sketched out above.  When times are good and metals prices are high, miners generally spend their cash developing new mines.  This creates periodic overcapacity when supply outstrips global industrial demand as all the new mines open at once.  But, unlike the case with soybeans or corn, excess capacity doesn’t disappear come winter.  Instead, it can stay for a decade.  What cures the oversupply is the eventual expansion of the world economy to the point where it can use all the raw materials being produced.

an example

I was a starting-out analyst when a supply-demand imbalance sent base metals prices skyrocketing in 1980.  I remember copper briefly hitting around $1.40 a pound and bringing previously loss-making capacity back onstream.  The price almost immediately fell back.  It took nine years for demand to expand to the point where it absorbed all available supply–and for the price to regain that 1980 high ground.

Another wave of new capacity pushed the price back down in the mid-1990s, where it stayed again until sharply climbing demand from China absorbed all the new output.  The price began to rise again in 2003.

For most metals, this pattern of feast and famine is common.  It’s not alone.  Chemicals and shipbuilding are the same way.  The common threads are:  commodity industry; long-lived assets with most of the capital in up front; capacity additions coming in large chunks.

Try to find a copper chart that goes back to the 1980s.  It isn’t that easy–suggesting to me that commodities traders aren’t as up on their history as they should be.

investment significance

I think that for base metals, and maybe for gold as well, we’re deep in the end-game transition from fat years to lean.  It has less to do with the state of demand in China than the state of supply among mining companies.  If I’m correct, time–and the accompanying gradual world economic expansion–is the only cure.