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Gold industry’s net free cash flow is a disaster

Here's another reason investing in gold shares has been such a loser: despite record prices for the yellow metal, the industry's net free cash flow position has been negative for the past five years. The scary figures for the gold bugs on net free cash flow come courtesy of DBRS, the bond rating agency, which has just penned a major piece on the industry.

It created a basket of the 10 major gold producers representative of the industry– familiar names like Barrick Gold, Goldcorp, Newmont Mining and AngloGold Ashanti – and looked at their collective metrics on such items as profitability, debt as a percentage of capitalization and cash flow.

Net free cash flow is the amount of money a company has left over after paying dividends and funding its working capital and capital spending needs. If it's positive, the company is spinning out more cash than it needs. This money is then available for stock buybacks and other shareholder pleasing activities. If it's negative, a company has to draw down its cash balances, raise new equity, or borrow.

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Given that the price of gold hit new record of just under $1,900 (U.S.) an ounce last year, the industry was net free cash flow negative every year from 2007 to 2011, a staggeringly poor record.

If the industry isn't spinning out cash when times are good, it does raise the question of how poorly the companies would do if bullion prices actually slid, which they've been known to do from time to time.

DBRS, as a bond rating service, was evaluating the industry for fixed income investors, and there were some encouraging results, at least for bond holders. The industry maintains a low level of debt, relative to its entire capitalization. Over the past five years, the gross debt to total capitalization ranged from 14.9 per cent to 19.5 per cent.

The firm liked this metric, saying that gross leverage below 20 per cent "is generally considered exceptional" for the mining companies it rates.

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