The Debt of Gold Miners—Those Folks Who Produce the Ultimate Hard Asset—Is Increasingly Trading As Junk
11/03/2014 5:32 pm EST
The bond market is selling off the debt of gold mining companies, and MoneyShow's Jim Jubak thinks investors should watch for signs that a company is burning through cash since, for this sector, in this environment, cash is king.
Next danger for gold mining companies? The bond market.
And if you like irony, you'll appreciate this: gold mining bonds-the debt of the companies digging the ultimate hard asset out of the ground-are increasingly being traded as junk.
As lower gold prices have hit gold miners' revenue, and as higher costs have eaten into profits, the bond market is selling off the debt of gold mining companies. Some now trade as junk, even though they're sitting-pardon the expression-on a gold mine of hard assets.
The problem is that many gold miners carry a heap of debt, and with gold now down to $1160 an ounce, an estimated one-third of the gold mining sector is losing money. Many of these are the same companies that loaded up on debt to buy assets when the price of gold was soaring.
And, frankly, right now, traders and investors are selling gold mining bonds and asking questions later. Both Barrick Gold (ABX) and Kinross Gold (KGC), for example, carry official investment grade ratings on their debt. But in the credit-default swaps market, where investors can buy derivatives to hedge against debt default, the companies' swaps are trading well below their official ratings. Barrick, for instance, carries an official Baa2 rating from Moody's Investors Service but its swaps trade at Ba2, three levels below that official rating. Swaps for Kinross trade five levels below the company's debt rating.
In this environment, it's important that investors distinguish between real cash losses and paper losses. Just about every gold mining company took another round of write-offs this quarter as the sector marked down the value of acquisitions made when gold prices were higher. Those write downs are painful and they certainly suggest that many gold companies are still be overvalued because they're carrying assets at inflated prices on their books, but a write down-like the $668 million charge Yamana Gold (AUY) took to write down the value of its C1 Santa Luz, Ernesto/Pau-a-Pique and Pilar mines in Brazil-doesn't cost a company cash.
To stick with this example, Yamana's third quarter earnings report was ugly but not nearly as life threatening as it seemed. The net loss for the quarter came to a huge $1.17 a share ($1.02 billion) but most of that was due to one-time paper charges. Taking those out made the picture somewhat better: The adjusted loss was just $12.5 million or a penny a share. Yamana Gold is a member of my Jubak's Picks portfolio. It is the last gold stock that I own in that portfolio. At today's price of $4.01, it is an interesting swing trade to, maybe, $6 a share. But I think we're still a long way away from the turn in the sector.
In an environment where selling gold mining assets at a decent price is nearly impossible and where capital markets are reluctant to lend money to gold mining companies at any price, what investors should watch for are signs that a company is burning through cash. In this market, and for this sector, cash is king. And the companies that will get pounded are those that are in danger of running out of cash before the cycle turns.
The debt markets aren't making surviving to the turn any easier on gold mining companies. It's not just that collapsing debt prices make it hard for gold miners to raise capital but the plunge in bond prices to junk levels sends a message back to the equity market that the sector is going bust. Obviously, that's not true. The assets here are about as hard as any assets can be.
But that doesn't provide much safety in a market where it is quite possible to feel that gold prices won't come back before everybody goes bust.