Gold mining stocks take another hit--from better accounting

03/04/2013 2:47 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Just what the gold mining sector doesn’t need right now: More accurate accounting for the costs of mining.

Oh, a more accurate measure of how much it costs a gold mining company to get gold out of the ground is way over due and much needed. But right now it introduces another element of uncertainty into a sector that has been pummeled so far this year.

The price of physical gold fell again today to $1571 an ounce. That follows on a 5% February retreat that marked the fifth straight monthly decline. That's the longest slump since 1997.

And the shares of gold mining companies have lagged the price of physical gold. That’s nothing new—gold stocks have underperformed physical gold in each of the past six years. But the performance lag has become especially brutal in the last year: as the price of physical gold has plunged the price of gold mining shares has plunged even faster. For the year ended on February 27, 2013, Barrick Gold (ABX), for example, is down 34.63%, shares of Goldcorp (GG) are down 30.31%, and shares of Newmont Mining are down 31.7%. In the same period the price of gold is down “just” 28.8%.

What’s wrong? Costs.

Here’s a stunning piece of analysis from Credit Suisse. In 2009 the all-in costs for gold producers were so high and so close to the price of gold that the margin per ounce was less than $100. In 2011 thanks to the soaring price of gold the margin per ounce had climbed to more than $200. In 2012 margins again fell to less than $100 an ounce. Projections for 2013 show a margin of a little more than $100 an ounce—if costs come in near expectations.

The problem for investors is that gold miners don’t use anything like this all-in cost in reporting on their costs. (Some companies do give investors all the data they need to construct their own estimates of all-in costs, but not all do so.) Most earnings reports in the industry use an accounting measure called cash costs—which excludes such expenses as exploration. As it has become harder to find gold deposits (increasing exploration costs) and as ore grades have fallen in many mines (increasing the amount of rock that has to be moved), the differences between all-in cost and cash costs have become increasingly significant.

CEOs at mining companies, feeling increasingly pressed by investors’ preference for ETFs that hold physical gold to owning the shares of gold miners (that preference increases the cost that gold mining companies have to pay to raise investment capital,) have been looking for ways to attract more investors. They’ve added dividends to their shares—since physical gold doesn’t pay a dividend. And now some of the biggest gold mining companies are reporting all-in costs in effort to make it easier for investors to figure out costs and margins.

As some one who has been hammering at the idea of looking for shares of the gold miners that combine an expanding production profile and low-end costs, I certainly applaud the new accounting stance. But I also recognize that the new accounting has the potential to reshuffle investor’s ranking of what companies are the lowest cost producers. All in cost accounting means, for example, that companies that are spending a lot of money to keep production at current levels will show up as higher cost producers as the costs of moving rock in low grade mines gets factored in. All in cost accounting will also put the costs of exploration into the mix, which means that companies that can increase production by expanding existing mines—cheaper than searching for brand new deposits—will get a cost edge.

Gold miners that have moved beyond the bulk of their spending on exploration and expanding production and are now close to the sweet spot in their cash flow streams include, according to data from Credit Suisse, Yamana Gold (AUY), a Jubak’s Picks member http://jubakpicks.com/  and Agnico-Eagle (AEM.) (Although Yamana Gold is down roughly 6% today on jitters over the company’s exposure to Argentina and the possibility that the Argentine government will expropriate Yamana’s mining interests there.)

Looking out six months to a year, Credit Suisse sees a pick up in cash flow at Barrick Gold (ABX), Eldorado Gold (EGO), and GoldCorp (GG), another Jubak’s Picks member. Companies that are in the wrong spot in their cash flow cycle include Kinross Gold (KGC) and Newmont Mining (NEM.)

I’d emphasize that we’re in the early stages of this accounting change and figures are still subject to big changes. And I certainly wouldn’t expect that the new standards will immediately boost the prices of gold stocks that come out on the right end of the cash flow schedule.

But, hey, I’d rather be on the right side of the cost trend than not in the long term.

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 Goldcorp and Yamana Gold as of the end of September. For a full list of the stocks in the fund as of the end, of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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