|
Brian
Eriksen Noer
April 04, 2005
Economic
Indicators for Gold Stock Investors to Consider: Currency, Production Costs,
and Exploration
Stock
market investors in the gold mining sector should be aware of three areas of
focus when planning an investment strategy. The three interconnected
financial metrics of US dollar fluctuations, production costs for mining
corporations, and exploratory activity, each affect the market in different
ways and the following report outlines the type of environment that market
participants are forecasting for this industry. Brian Noer reports for Gold-MiningStocks.com.
US
Dollar Fluctuations
As a rule of thumb, the
rise and fall of the US dollar shares an inverse relationship with the price
of gold. Current US trade and budget deficits have led to a three year long
decrease of the dollar, although the Federal Reserve seems intent upon
regular interest rate hikes in the near short term to regulate the
downslide.
“We think that the
gold price is consolidating at the moment and will continue to track the US
dollar,” said Running Fox (TSX-V: RUN)
President, Michael Meyers. “The US dollar is still on a general decline,
even though the Fed has recently raised interest rates by 25 basis points.
This is of course helping to strengthen the dollar in the short term and
therefore gold has lost some of the gains that it had.”
“We believe however, that
the US dollar is going to be on a further decline as the US is looking to
pay back debt (originated when the dollar was high) in lower valuated
dollars. Currently we are in a consolidation phase and gold is still a
profitable market to be in. The world is definitely growing and it needs raw
resources such as energy, gold, and other metals to keep everything
running.”
Placer Dome (TSX,
NYSE: PDG) is a senior gold corporation, producing approximately
3.7 million ounces of gold and about 410 million pounds of copper annually.
“We have obviously enjoyed the benefit of the increase in gold prices,”
said Greg Martin, Director, Investor Relations with Placer Dome. “Over the
last six months gold has been in a reasonable range although it hasn’t
really broken to new levels since late last year. We expect that to change
later in 2005.”
Due to recent interest rate
hikes in the US, the dollar has been trading within a range. Martin states
that there are countries that are beginning to exhibit concern about their
currency valuations relative to the US dollar. “There is not a lot of
desire from countries like Canada, Australia, or Europe to see their
currencies strengthen farther. This combined with a slightly tighter
though still accommodative monetary policy in the US has lead to the recent
stability in the dollar.”
While the price of gold has
risen in US dollar terms, the rise in other currencies has been limited. The
recent environment has exhibited an interesting dynamic where US based
operations have seen a significant economic benefit from the price of gold,
whereas operations based in Canada and Australia have seen only a marginal
benefit from the price of gold, and those in South Africa have seen their
margins come under significant pressure.
Companies with exposure to
US based operations tend to be faring better due to the weakness of the US
dollar compared, for example, to South African mining companies. As the Rand
has quickly appreciated against the US dollar, South African producers are
not benefiting from the US dollar increase in gold prices. The Canadian
dollar has gained 21%, and the Australian dollar 30%, against the US dollar
in the past two years.
“About 25% of our
production is US based and about 50% of our costs are US dollar
denominated,” said Placer Dome’s Martin. “We have been realizing
benefit from the market situation, but there have been some cost pressures
imposed by the macro economic environment, which have impacted our non-US
production.”
US based producers would
seem to be in optimal positions as regards benefiting from currency exposure
versus rising gold prices. As shown below however, some gold mining
companies have strategies in place to maximize their profit shares even
within this restrictive environment.
Production
Cost Considerations
Despite buoyant gold prices
(the price of gold has risen consistently for the last four years and
industry analysts project that it will climb another 7% in 2005) and
increased top line growth, costs are currently trending up due to industrial
production growth (resulting in squeezed profit margins) as well as the
downward trend of the US dollar. Gold companies generally report their
operating costs (cash/production or both) per unit based on an industry
standard, making a comparative analysis easier for stock market investors.
Cost pressures usually
track the general economic cycle (industrial production (IP) growth is one
on many statistics/indicators). As the cycle progresses, rising costs for
overhead considerations such as labor costs, equipment, and materials has
outpaced gains in bullion and are therefore affecting many mining
companies’ profit margins. The companies that can insulate themselves the
best against cost increases are the ones who will be able to maintain that
margin growth.
Placer Dome’s Martin said
that when speaking of costs in this industry it is important to break the
term down into three components. “1) the pure currency impact on costs,
which is a translation issue. We pay our employees, and purchase supplies in
local currency, but we report in US dollars,” said Martin. “2) The
commodity inputs of the gold sector: diesel, energy, steel, cyanide, acid,
and tires to name a few. 3) The way in which gold companies manage their
assets which is typically to maximize the Net Present Value (NPV) of their
mines.
“As a result of this
strategy, production managers adjust the cutoff grade and this often means
that when gold prices rise the cutoff grade of an operation is actually
reduced. In this scenario a mine will still create greater value from a
longer term perspective, but that might mean processing lower grade material
in the shorter term. As a result, cost and grade go hand in hand – the
production manager is making a conscious decision to increase costs but the
mine is still is creating increased value for the shareholder.”
“Production costs and ore
grade are the major considerations for a company in the gold mining
industry,” said Marc Cernovitch, V.P. of corporate Development with Halo
Resources (HLOSF.OB). “Small
scale mines, are very sensitive to the intensive upfront capital
requirements. It is most important to engineer an optimum production
scenario, which ensures that the operation is mining the highest possible
grade of ore. Narrow vein gold mines in general, need to focus on selective
small scale mining methods and allowing a mine to produce at its natural
rate.”
Halo strives to source
‘near production’ assets featuring area exploration potential so that
they can employ a custom milling approach. “It is desirable to feed the
mill from a number of ore sources,” continued Cernovitch, “not push the
mine to a point where you end up diluting the feed to the mill with waste
rock.” Cernovitch warned that when preparing a mine for production,
management should assume that they will go through a down cycle in metal
prices. “Ideally, a mine should have enough resource potential to be able
to survive at least two down cycles when making your production
decisions.”
“It is very difficult to
try to predict what commodity prices or currencies are going to do. For a
small scale producer like us, it is important to ensure that your operations
can survive at low metal prices and it is unwise to make production
decisions solely based for example, on today’s gold price.”
Exploratory
Activity
Another issue of concern to
investors is the fact that it is becoming increasingly difficult to source
new gold deposits. During the past ten years exploratory activity has been
on the decrease – a result of declining gold prices and increasing cost of
production. Therefore, companies that have available access to development
projects are positioned well - able to keep their production flat if not to
increase them. According to an industry analyst, Placerdome, based in
Vancouver, for example, has a good portfolio of growth projects.
Exploration has been a very
important component of Placer Dome’s strategy and success over the past
few years. In 2003 the company featured a very successful exploration
program followed up in 2004 by replacing all of the gold mined with
exploration discoveries at their operating assets. “We are really the only
senior company that can say that we were able to achieve that. All of the
ounces that we replaced came from areas where we have existing
infrastructure and operating mines. We feel that from a ‘maturity of
assets’ perspective, we control some of the most prospective areas.”
“Our exploration focus
has been at our existing mines,” said Martin, “we are spending about two
thirds of our exploration budget in and around our mines. That is a
reflection of the fact that we think that the ground around our mines, and
the type of mines that we have, are ones that we can continue to replace and
add reserves to. We have a number of really long lived underground
operations where we continue to drill and find gold. Our company has been
the most successful of all of the seniors in terms adding to their existing
asset base.”
One of the issues that
investors in the gold sector should take note of is the supply and demand
dynamic. “The supply dynamic has been challenged due to the lack of
investment and exploration when the gold price was low,” continued Martin.
“It was expected that if the price of gold went over $450/oz then new
projects would materialize and the market would be revitalized. The reality
however is that the US is a small proportion of global supply, and we have
seen reductions from companies based in other countries. Therefore the
supply side of the market will remain challenged.”
Conversely, according to
recent demand numbers (collated by Goldfields Mineral Services), demand was
robust in 2004, up about 6% on a global basis, showing that the fundamental
gold market is in a very positive position for continued longer term
strength. Investors realize that gold is also a financial instrument,
trading off of other financial metrics than merely supply and demand, and
due to the state of the US economy, (US deficits, debts and savings levels)
this environment provides a very positive macroeconomic backdrop to the gold
market. Martin stated that these parameters are currently aligned in terms
of being supportive to the gold market.
The
Canadian Market
“Canada is a wonderful
environment to be mining in,” said Halo’s Marc Cernovitch. Halo
Resources is a development company with positive exploration upside,
featuring properties in Ontario, Quebec and Manitoba. Halo focuses on
Canadian based ‘advanced exploration, near-production’ assets.
According to Cernovitch,
mining in Canada is experiencing a revival. “There are progressive
governments in place (in each of the Provinces in which we have properties)
that actively promote mining activity. For several years mining in BC was on
a decline due to restrictive government policies, but the current policies
provide a much more viable atmosphere, and consequently we are seeing a
return of exploration activity. Manitoba has one of the most accommodating
attitudes towards mining in the world, in terms of their progressive
policies towards providing support to the mining industry.”
Michael Meyers, President
of Running Fox is also enthusiastic about the opportunities afforded by the
Canadian market. "We are very encouraged about our 2004 work on the
Brett Gold Project; and think that there is a very good opportunity to
identify a significant and economic high-grade gold reserve. An informative
summary of the recent work is on the www.foxgold.ca
website and is titled, ‘Brett Assessment Report’”.
Brian
Noer
Brian
Noer has a degree in Business and Economics from the
University
of
Western
,
Ontario
. His
career in the financial markets spans fifteen years and several continents,
including: Manager with The Bank of Montreal in Canada, Associate Analyst
with the structured finance group at Moody’s Investor Services in the UK,
and Editor for several financial trade magazines in the UK for both Thomson
Financial Publishing and Euromoney PLC (titles include Thomson’s trade
magazines “The International Securitisation Report”, and “Capital
Market Strategies”, and Euromoney’s “Asset Finance International”).
Brian recently joined the InvestorIdeas.com portal team as a Writer, Editor
and Research Associate.
Disclaimer:
www.InvestorIdeas.com/About/Disclaimer.asp
©Copyright InvestorIdeas 2005
|
