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5 Ways to Play the Gold Miner Spread - 8942 views
BALTIMORE (Stockpickr) -- The old saying goes that “all that glitters isn’t gold” -- but lately all that’s gold hasn’t glittered much either.
Gold prices have made a reasonably strong run in 2011, spurred on by a combination of gold’s attractive status as an “alternative currency” and investors’ flight to quality from stocks. More recently, however, fear of equities has been the primary driver of appreciation in gold prices. That’s something that’s been evident from the lock-in-step ascent of both gold and treasuries -- two fundamentally disparate asset classes.
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The Fed’s Operation Twist smacked down gold prices by making treasuries the comparatively more attractive anti-stock trade, drying up demand for the metal. Now the big question is whether gold has run its course -- or whether investors have a major buying opportunity for the yellow stuff.
With equities still under pressure and the favorability of treasuries a temporary phenomenon, I think that the latter is more likely. Already, gold prices have been basing at a technical support level. A retest of highs is certainly plausible right now.
But that’s only half of the story.
The other half is in the gold miners. Traditionally, gold miners have been the best way for stock investors to get exposure to gold price movement. Because gold miners earn more when gold prices are higher, it’s a logical way to profit from gold price appreciation. But that relationship has broken down a bit lately.
As stocks got shellacked since the beginning of the summer, the market dragged down miners while gold prices rallied. The spread between those miners and spot gold prices is a major trading opportunity right now.
That spread is most apparent in the NYSE Arca Gold Bugs Index, an index of 16 gold miners that don’t hedge beyond 1.5 years; that lack of hedging ensures that their profitability matches the movements of gold prices. Since the end of April, the negative spread has reached massive proportions. It’s only the third time that the spread has turned negative since 2000 -- and right now, the only other time when gold miners were so discounted was in October 2008.
Investors who decided to invest in Gold Bugs Index members at that low in the spread were rewarded with 171% gains in the 12 months that followed. That makes this gold trade even more attractive right now. Here’s a look at five ways to play the gold miner spread.
$9.5 billion miner Yamana Gold (AUY) is one of the more well-known names in the gold business, with reserves in excess of 22 million ounces. As of today’s open, Yamana is flat on the year, having essentially erased any gains that the company had earned in 2011. Third-quarter earnings on Nov. 3 could be the wakeup call for Wall Street that this firm is able to collect a whole lot more for each ounce of metal it pulls out of the ground.
Since the start of the financial crisis, Yamana has been aggressively increasing its gold production capabilities, hiking its output more than 20-fold to bring up more than 1 million gold equivalent ounces (that is, including other metals to gold by value) last year. In the mining business, costs are everything -- and margins essentially come down to the difference between what it costs to pull gold out of the earth and what the company can sell the metal for. Yamana sports very low costs for the industry, averaging $450 per ounce last year -- that affords the firm pretty hefty profitability with gold prices currently sitting above 1,600.
Financially, Yamana is in sound shape. The company has historically supported its brisk growth rate through acquisitions, a strategy that’s generated approximately $459 million in debt at last measure. That’s offset by $826 million in cash and investments, a value that’s more than doubled in the last year as Yamana carried truckloads of cash into its corporate coffers. The firm makes up 4.43% of the NYSE Arca Gold Bugs Index.
Iamgold Corporation (IAG) is a midsized gold miner with operations in North America and Africa. The firm produced almost 800,000 ounces of gold last year, making it a major contributor to gold supplies. Not surprisingly, gold isn’t Iamgold’s only offering -- other metals (such as silver and copper) are commonly produced alongside gold. In IAG’s case, the No. 2 metal is niobium, a rare earth metal that’s used to create everything from superconductors to the magnets in MRI scanners.
That exposure to a class of metals with their own scarcity story and massive industrial demand makes Iamgold one of the more attractive gold mining stories right now -- even if rare earths have fallen off a cliff lately.
As with Yamana, Iamgold has fuelled most of its growth to date with acquisitions, opting to spare itself from the risks of prospecting new projects. That’s a strong strategy, but it’s not a cheap one. That said, investors will appreciate the firm’s financial strength – with more than $1.1 billion in cash and investments and no debt, IAMGold is among the best-positioned firms to wait out short-term contractions in gold’s spot price.
Onto the world’s largest gold producer, Barrick Gold (ABX). Last year, Barrick produced 7.9 million ounces of gold from its 25 mines spread throughout North America, South America, Asia and Africa -- a small fragment of the firm’s current 140 million ounce reserves. Copper is the other major metal that Barrick pulls out of the ground; the firm extracted 368 million pounds of it last year.
One unique aspect about Barrick is the firm’s aversion to mines with excessive political risk. While gold operations tend to take place abroad, Barrick’s flagship mine, Goldstrike, is actually located in Nevada. Alone, it accounted for more than 15% of production last year -- and another 20% of production is domestic.
Because Barrick’s gold mining operations are mostly in countries with stable governments, the nightmare scenario of a despot nationalizing his country’s gold mines is much less likely.
Barrick, a holding in the portfolio of Daniel Loeb's Third Point, has levered up its balance sheet recently, doubling its debt load in the last quarter to fund an acquisition -- but record low rates and the firm’s massive gold production makes the move marginally impactful on its overall financial health. While it doesn’t enjoy the same cushion seen by firms like IAMGold, Barrick is still in solid shape.
The firm makes up 15.03% of the Gold BUGS Index.
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Even though Newmont Mining (NEM) is the sole firm on this list without “gold” in its name, don’t let that fool you – with 6.5 million ounces of gold produced in 2010, Newmont weighs in as the second-largest gold producer in the world. The firm also produced 600 million pounds of copper last year.
Newmont has some of the lowest costs in the industry thanks to a number of mines that the company owns in places like Peru and Indonesia. The biggest challenge is going to be finding that next project; despite amazingly low extraction costs in those two countries, Newmont has come up against regulatory and local challenges in expanding the development of both of those sites.
Those sorts of stumbling blocks have pushed the firm’s focus back to North America recently -- the region is currently second only to Asia for production.
Newmont makes up 11.4% of the Gold Bugs Index.
Goldcorp (GG) is a $35 billion senior miner that produced 2.5 million ounces of gold last year. Like Barrick, Goldcorp has avoided excessive exposure to political risk -- the firm’s mines are located exclusively in North and South America.
The firm’s 60 million estimated ounces of reserves are cheap, too. Legacy mines, like Goldcorp’s Red Lake project in Canada, have production costs under $300 per ounce. While that sort of cost structure may not be the norm across Goldcorp’s portfolio, it’s indicative of the firm’s overall profitability -- net margins were in excess of 35% last quarter. Because Goldcorp doesn’t even hedge short-term gold price fluctuations, it’s one of the best ways to get exposure to price hikes.
Like its peers, Goldcorp sports a solid balance sheet. The firm has more than $3 billion in cash and investments, versus a paltry $715 million in long-term debt.
To see these stocks in action, check out the Gold Spread Plays portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.