The "vomiting camel" is not a widely known pattern in technical analysis of securities. But it's an apt description of what looks like two humps, a neck-like downward trend, and then a sharp drop that resembles a rapid regurgitation.
Which brings us to gold, its miners, and the investors who took a chance on them earlier this year as the precious metal was mounting a comeback from a terrible 2013. When gold is rising, miners offer investors superior operating leverage because their profits rise quickly. Add extra financial leverage – i.e., debt – and mining stocks offered an excellent road to returns as gold rebounded.
Except that, as we approach the end of 2014, the graphic representation of gold prices resembles that ailing camel. And, since the March 13 peak for gold prices, major miners are down 25 to 60 per cent from already-depressed prices. Their shareholders might now be just as nauseated.
It wasn't so long ago that sell-side analysts were "stress-testing" their models of miners' earnings and balance sheets by plugging in a low of $1,200-per-ounce gold. Now, with the metal failing to hold that level (most-traded New York gold futures closed Friday at $1,169.80), the analysts are using $1,100 and $1,000 in their models – and the results suggest, at best, no more growth spending, continued cost reductions, and dividend cuts.
Below $1,100 per ounce, "equity value erodes," RBC Dominion Securities Inc. analyst Stephen Walker says, rather kindly.
Scared yet? You absolutely should be. Gutsy – or crazy – enough to double down, or even get into gold stocks for the first time? Here's the lay of the land.
The biggest of the miners, by revenue – Barrick Gold Corp. and Newmont Mining Corp. – are also the most in debt. (They have the most, on an absolute basis, as a proportion of their capital, and their debt-to-earnings ratios are above-average.) That makes them less appealing if gold prices are stagnant or falling, and analyst sentiment reflects that: a majority of the analysts have "holds" or "sells" on the two names.
Barrick gets credit for its low-cost performance at many of its mines, but analysts' focus remains on its debt burden. Management said in its most recent earnings that its priority is to restore its balance sheet "to a position of strength." But analyst Jorge Beristain at Deutsche Bank says he is "increasingly concerned" about its ability to do so, given gold-price headwinds, "dimming prospects for its copper business," and the need to take action on its partnerships.
Analysts are more sour on Newmont than on any of the major producers, with just five of 25 analysts covering the company rating it a "buy." Analyst Peter Ward of Jefferies, who is pessimistic about the entire gold-mining industry, calls Newmont his "top short idea" and said in mid-October it was "a case study in overvaluation" because, he believes, Newmont's gold reserves, while properly reported, are not of as high quality as investors believe.
The miners with a better debt profile are generating more enthusiasm. Goldcorp Inc., which generates more EBITDA, or earnings before interest, taxes, depreciation and amortization, each year than it has net debt, has 20 "buy" recommendations among the 26 analysts following it. The company missed expectations on its third-quarter earnings, which Patrick Chidley of HSBC Securities Inc. calls a buying opportunity, particularly given a dividend yield of 3.2 per cent, second-best among the major gold producers, behind Newmont.
The healthiest balance sheet, on a debt-to-capital and net-debt-to-EBITDA basis, belongs to Eldorado Gold Corp. As a bonus, it's one of the lowest-cost gold producers, says analyst Kerry Smith of Haywood Securities, who has a "buy" rating and $9.50 target price, versus Eldorado's close Friday of $6.38.
Mr. Walker of RBC says Goldcorp and Eldorado are among the gold producers "best positioned to withstand a gold price downturn." He also names B2Gold Corp. and New Gold Inc. among TSX and U.S.-listed companies.
Two of the major gold names are the "winners" among the bunch since the March peak, if by "winners" you consider dropping a mere 5 per cent to 15 per cent. Franco-Nevada Corp. and Royal Gold Inc. are royalty companies, rather than operators. They have more cash than debt, and each pays dividends (1.7 per cent and 1.4 per cent, respectively). "The royalty-streaming companies … remain in a strong position," says Mr. Walker.
The worst performer since March has been Yamana Gold Inc., hurt by an earnings report Oct. 30 that featured big non-cash charges for its Brazilian mines and extra tax expense in Chile. The shares are down by nearly a third this month, which has made it appealing to analysts: 17 of 25 have a "buy" rating. Josh Wolfson of Dundee Securities sounds a warning note, however: while the analyst consensus suggests "considerable free cash flow prospects," he says, he believes that at gold prices below $1,150 ounce, the company "will be challenged to generate net cash."
It's worth closing, actually, by returning to the risks involved in buying any mining stocks. Mr. Ward recommends a "pair trade" of owning bullion while shorting gold-mining stocks.
"Given the margin pressure we foresee, gold equities remain quite expensive, despite their dramatic fall," he says.
"We'd agree that many gold company managements have 'found religion' and are now focusing on returns and free cash flow rather than just growing production. But, after depleting many of their low cost ounces, finding religion on returns may not stop further gold equities weakness unless the gold price improves. And, we are skeptical that it will rally materially, especially if interest rates increase further."
1-year
Deep in the hole
As gold prices fell this year, gold miners' shares fell farther, with losses of up to 65 per cent since the March 13 high for bullion. With the concern that gold prices will stay below $1,200 (U.S.), and perhaps fall more, analysts are favouring the miners with the best balance sheets, where earnings can support the companies' debt burdens.