Which Oz Gold Stocks Are Under Pressure?

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This story features ST. BARBARA LIMITED, and other companies.
For more info SHARE ANALYSIS: SBM
The company is included in ALL-ORDS

-Gold pre-empting something bigger?
-Miners have to take a tight rein on costs
-Gold cash costs to reveal more detail
-Marginal mines may have to close
 

By Eva Brocklehurst

What is gold worth? Everyone knows it's valuable but how valuable? It's a complex question because gold is more than just a commodity that's subject to supply and demand. The traditional view is that gold is a hedge against inflation. Therefore, gold prices should reflect changes in inflation. They do, over a long time frame, but Credit Suisse has found there are significant deviations from the long-run average in shorter timeframes. Gold can get ahead of the fundamentals and become too expensive, as it did in 1980 or has done over the last couple of years.

Credit Suisse looks at the theory that gold prices rise if US real interest rates go below 2.5-3%. This relates to the fact that central banks tend to set interest rates in line with an inflation target, coupled with the economy's long-term growth rate. If interest rates are below this level policy settings are loose, there is excess liquidity in the market place and expectations are for inflation to go higher and therefore gold prices to go higher. So, what went awry this time? Global real interest rates are very low, there is excess liquidity but inflation is not increasing and gold prices have dropped.

Credit Suisse finds the spread between nominal GDP growth and policy rates a reasonably good proxy for excess liquidity. As we all know, central banks in most major jurisdictions have kept policy rates well below nominal GDP growth and increased liquidity. Right now, with gold moving lower instead of higher, the gold market is leading the relationship and what this may be foretelling, in Credit Suisse's view, is there's a shock coming to liquidity in the near future.

Credit Suisse maintains that if gold is really foreshadowing a negative shock to global liquidity and growth, then outright weakness in gold has broader implications than just for the commodities. It means corporate earnings will suffer. Moreover, there is now the absence of an effective monetary lever to re-stimulate growth. Taking all this on board, Credit Suisse favours defensive equities. Mining stocks may be cheap relative to the commodities that underpin them but the broker struggles with the idea of buying resources on this basis, especially when commodity prices may have more downside. The broker estimates that miners are discounting a 30% decline in Australian dollar commodity prices. Such a decline may be possible, but the real issue is whether there is a strong recovery in 2014. On this note, Credit Suisse has not yet seen a catalyst for commodity prices to either stabilise or rise.

Deutsche Bank notes the selling which sent the gold price down US$200/oz in two days was largely triggered by technical pointers. Stop-loss sell orders were triggered and long positions were liquidated. Technical breaks in the price trend occurred at the key levels of US$1525/oz , US$1400/oz and US$1375/oz – last seen in late 2010. Fundamentals are at play too, in a similar scenario for Deutsche Bank to that painted by Credit Suisse. Deutsche Bank believes the selling is related to "a capitulation in inflationary bias associated with extremely accommodative monetary policy". The results are being seen across the globe and the broker cities disappointing growth data in China, soft US economic indicators amidst very low inflation, and a contraction in the European Central Bank's balance sheet. Capital flows continue to move towards the US as the place of low risk yield, reflected in US equities.

This savage downturn in gold prices has heralded a new era in assessing cash costs, Citi maintains. Cash costs form the basis of mining sector performance measurement. These disclosures are not subject to the rigours of accounting standards and are open to manipulation. The broker believes gold sector cash costs have been "comically unhelpful" in arriving at accurate free cash flow estimates. A new benchmark from the World Gold Council is expected mid 2013 to address this issue and should be adopted by major miners, if they haven't already moved some way in that direction. Citi thinks this should improve understanding and confidence in the sector, but it will also flush out costs that have been hidden previously.

Citi notes US-based gold miner Newmont, one of the council members, has pre-empted any changes and provided a breakdown of all-in sustaining cash costs. This includes attributable costs applicable to sales, by-product credits, exploration expense, advanced projects and research and development, other expenses, and sustaining capital. Citi suspects this is where the new definition could be headed. As components within fully allocated costs become more apparent, the broker cautions that free cash flow estimates may be pressured. This has implications not just for the gold sector, but also for miners more generally. They're watching this space. Citi's highest cost Australian gold producers are St Barbara ((SBM)), Resolute Mining ((RSG)) and Kingsgate Consolidated ((KCN)). Some stocks which do better overall also have some high-cost mines such as OceanaGold's ((OCG)) New Zealand assets and Newcrest's ((NCM)) Bonikro and Hidden Valley.

Drawing on a similar thesis, Deutsche Bank has examined the all-in cash costs of gold miners. The broker defines these to include C1 operating costs, including mining, processing and by-products, royalties, sustaining capital costs, near-mine exploration and evaluation, and corporate costs. Using this definition the broker has estimated that Medusa Mining ((MML)) has the lowest all-in cash costs of the Australian sector contingent. Regis Resources ((RRL)) is also very competitive. The highest all-in cash costs are sustained by Evolution Mining ((EVN)) but the broker expects this stock to improve this measure over 2013. 

Using all-in cash costs the broker finds only eight of 23 assets surveyed across the seven Australian gold stocks covered are profitable at this price. On average, the stocks are pricing a flat US$1190/oz, showing value even in the current gold environment. The broker does not expect companies will make changes to operations until the volatility subsidies but gold companies will be forced to respond if the gold price holds at US$1350/oz for a prolonged period. If gold does indeed stay at these levels the implications could involve focusing on high grade material to reduce costs per ounce, removing future expansion plans from operations, closing high cost operations and taking a look at funding requirements. Nevertheless, Deutsche Bank believes the quality stocks in the sector are not being valued adequately.

Drilling deeper into gold equities, the prognosis from Goldman Sachs, on the basis of a gold price forecast for 2014 of around US$1,350/oz and moving to US$1,250/oz in 2015, is that no company will operate a mine above US$1,600/oz and will either close or find ways to reduce costs. Goldman has ranked all 25 gold mines under coverage on a gross cash cost basis – which includes all mining, processing and royalty costs as well a most recent estimate of additional costs such as deferred waste movement and sustaining capital. The broker concludes that Australian companies with the least risk of generating negative cash returns are Regis Resources, OceanaGold and Medusa Mining. The mines at the top end of the cost curve are owned by larger corporations whose overall costs hide the expensive mines, such as St Barbara's Pacific assets and the aforementioned assets of Newcrest. 

Moving to FY15, Goldman expects, if the price forecasts are correct, that miners will start to make alterations to operations. For example, at Newcrest's Telfer mine there may be some opportunity to limit ongoing capex to keep the asset going but the broker believes lower grades will hinder future profitability there. In the case of another Newcrest mine, Cadia, this is made more complex because there are considerable by-product credits generated from copper production. As for Hidden Valley and Bonikro, being part of a larger organisation, there is the potential for carrying underperforming assets in the hope lower costs can be realised. The question must be asked – for how long? At St Barbara's Gold Ridge mine costs are well above the spot gold price and Goldman's long-term gold price. This requires a significant turnaround and the broker does not expect St Barbara will let the cash burn continue. Several cost saving initiatives are already underway and productivity improvements should deliver better results.
 

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