Are Gold Miners A Buy At These Levels?

Are Gold Miners A Buy At These Levels?

With the price of gold at relatively depressed levels, could now be the time to buy the miners?

After reporting earnings, three primary gold miners, for the most part, did not surprise market watchers. Yet it was the price assumptions for gold that might be worth noting.  Gold miners wrote down reserve estimates and took some degree of write-down in the 4th quarter of 2013, a report from Citi noted. Going into year-end reporting, Barrick Gold Corp. (TSE:ABX) (NYSE:ABX) had the most aggressive price assumption built into their model, at $1,500 per ounce.  But coming out of 2013, their gold pricing model was at $1,100 per ounce. Kinross Gold Corporation (NYSE:KGC) (TSE:K) had a $1,200 price target and Goldcorp Inc. (NYSE:GG) (TSE:G) had the highest price assumption at $1,300 per ounce.

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Is gold bottoming out?

What is exciting to investors is the notion that the price of gold may have recently completed a double bottom and, having breached the $1,300 level might resume its long term bull trend (see chart above, Source: Stock Charts).  If gold were to resume its bull trend, it would be particularly bullish for the miners, whose estimated cost of production ranges from the high of $1,000 per ounce at Kinross to a low of $950 per ounce at Barrick.  All three miners cut their reserve estimates as well:  Barrick Gold Corp. (TSE:ABX) (NYSE:ABX) cut estimates by 19%, Kinross Gold Corporation (NYSE:KGC) (TSE:K) by 16% and Goldcorp Inc. (NYSE:GG) (TSE:G) by 13%. The reduction in reserves comes as the World Gold Council noted that gold supply is currently contracting.

It is the low cost of production that caught the eye of the Citi analyst Brian Yu. The firm rates Barrick a Buy for three reasons, but also expresses concern.  In terms of positive investment thesis, Citi notes the strong base of production and reserves, the largest base of resources and reserves in the industry, and 3) gold prices are more sustainable than those for industrial metals during recessionary periods.  As for negative factors, it notes that gold is close to all-time highs on a nominal basis, a weak history of ROIC generation in the sector, and M+A risk. “Currently, we believe the positive factors outweigh the negative and the ETR to our target price supports a Buy rating,” the investor note says.

Risks noted in gold miners

In recommending Barrick, Citi notes several primary risks, including commodity exposure, political risk, and monetary and fiscal policy somewhat offset by the company’s geographic diversification and broad range of assets.  The letter also notes with concern that Barrick’s financial performance is highly levered to the price of gold, with all future production unhedged. “The market price of gold can be volatile and is highly sensitive to macroeconomic factors including economic confidence and growth rates, central bank policy, and government fiscal policy,” the letter noted.

In regards to project development, the letter noted Barrick Gold Corp. (TSE:ABX) (NYSE:ABX) aims to advance multiple new projects to drive future growth. “The process to bring a development project to production has many hurdles including project financing, permitting, regulatory compliance, staffing and construction. Any unexpected issues or delays could effect project delivery, increase project development and operating costs, and reduce the NPV of projects.”

The investor letter also highlighted the company’s mining operations are subject to variability in ore quality and structural issues which could potentially decrease production volumes and increase unit costs.  Further, the investment is heavily subject to currency fluctuation.

A key component of investment risk is political.  While approximately 61% of Barrick Gold Corp. (TSE:ABX) (NYSE:ABX)’s reserves are located in investment grade countries, the investor letter noted that government intervention, taxation, or regulation and the threat of civil unrest do present risks and could negatively impact production and operating costs. While attempts to mitigate this risk through a diverse portfolio of global assets is in place, “the impact from any of these factors proves to be greater than we anticipate, the stock could have difficulty achieving our target price; alternatively if the effect is less than expected the share price could exceed our target,” the letter noted.

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Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)

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