It’s early in the transition of gold mining companies to the lower price of gold, but I think we can already stake out a few of the important differences among the mining companies. On this scorecard, I think Yamana Gold (AUY) is a good example of what you should be looking for in the sector even if it may still be a little early in the transition to buy anything. (If you disagree with me on timing, I’d start with a stock such as Yamana. Yamana is a member of my long-term Jubak Picks 50 portfolio http://jubakpicks.com/jubak-picks-50/ And I do think Yamana is a good trading vehicle for this market in gold.) First, write downs. This is an obvious difference and all things else being equal, you’d prefer a company with less in write downs (such as Yamana) to one with more in write downs (such as Barrick Gold (ABX.) But the absolute size of the write down is actually less important than the details. A write down is just a paper expression of the fall in the price of gold if a company is simply writing down the value of current reserves. These write downs will go back into the company accounts when gold prices rise. They are, however, important in a more lasting way if they express a more permanent impairment of assets either through a sale or a closing or abandonment of a project. Second, how aggressively the miner is moving to reduce costs. Costs in the industry will come down by themselves as contracts for mining services and the like get renewed at lower prices because of the falling price of gold. Waiting for that to happen is a very passive approach. What you’d like to see here is a company attack costs now because with the price of gold low every bit of cost reduction is important to cash flows and a company’s need for financing and its ability to maintain outlays such as dividends. To give you a benchmark on the aggressive side, all-in sustaining costs at Yamana Gold fell to $950 an ounce in the second quarter, a drop of $64 an ounce or 6%. The company sees all-in sustaining costs falling to $850 an ounce in 2014. Three, how willing the company is to sacrifice a bit of current earnings in order to reap (potentially) higher returns when gold prices climb again. Yamana Gold reported second quarter earnings per share of 7 cents, 4 cents a share below Wall Street estimates. Revenue dropped 19.6% to $430,5 million versus the $486 million analyst consensus. The obvious cause was the fall in the price of gold, but like all gold miners right now Yamana had a decision to make on how much to increase production and sales to make up for lower prices. The company did increase gold sales to 233,714 ounces in the quarter but that was a relatively modest boost from the 223,279 ounces sold in the second quarter of 2012. Companies that decide to sell less gold now so they can sell more gold later are likely to take a short-term hit to their share price. (Yamana took a big hit today on that earnings miss, falling 7.33%, or 77 cents a share.) If you have a slightly more long-term view, however, that drop in share price today means you are able to buy tomorrow’s production (at tomorrow’s price) at a lower cost. Four, you would like to see a pipeline of new mines—with projected costs at the low end of the scale—ready to come into initial production in the next year or so with a reasonable production ramp taking full production out into 2014 or 2015. Projects that are further out than that have higher execution risks—the future is indeed uncertain. In the second half of 2013 Yamana has three new mines that will be ramping to full production by the end of the year. That will give Yamana a big bump in production in the second half of 2013—about a 30% increase from the first half with full 2013 production 13% above that for 2012. I think that’s a favorable production profile with a good trade off between higher uncertainty if the ramp were further away and the likelihood of higher gold prices if the ramp were further out. Looking out a little further, with all operating mines in full production Yamana projects production 30% higher in 2015 from 2012. Five, the fate of dividends in the sector is a useful indicator of a company’s read on cash flows. I like it that Yamana has said that it feels its current dividend of 26 cents a share is sustainable. Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did own shares of Yamana Gold as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/.
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