How to Play the Battered Gold-Mining Stocks
By BEN LEVISOHN | Barron’s SATURDAY, MARCH 2, 2013
Gold's bull market may or may not be over, but gold miners are sure acting like it is. Emerging-market investors can find opportunity amid the carnage by understanding the transformation taking place.
It's been a tough year for gold—and gold miners. The precious metal has dropped 5.6% in 2013, while the Market Vectors Gold Miners exchange-traded fund (GDX) is off 19%. Among the worst performers are companies based in developing markets, including South Africa's Harmony Gold Mining (HMY), which has plunged 31% this year, and Peru's Buenaventura Mining (BVN), which has plummeted 29%.
When gold was heading straight up, companies—desperate to increase their production—poured money into huge, expensive projects with little thought to the costs. Investors, meanwhile, were willing to look the other way, while pouring money into the stocks—even when performance was lagging and their stakes were diluted by share issuance. From gold's bottom in October 2008 through its peak in September 2011, the miners beat the metal by about 50 percentage points.
But with the price of gold no longer moving higher—it's about 15% below its peak—the gold miners ETF has shed nearly half its value. The companies, at least, have realized that the old growth-at-all-costs focus no longer works, says JPMorgan analyst John Bridges, and have begun to shift toward a more sustainable business model. They've been shedding unprofitable mines, providing investors with more accurate information on production costs, and focusing on free cash flow and dividend yields.
JAMIE SOKALSKY, CEO of Barrick Gold (ABX), acknowledged as much after the company issued its fourth-quarter earnings on Feb. 14, saying in a press release that "rising costs, poor capital allocation, and the pursuit of production growth at any cost in the industry have led to declining equity valuations across the sector." He promised to do better.
Companies that operate solely in emerging markets have had to be even more creative. South Africa's Gold Fields (GFI) for instance, split in two, with a new company, Sibanye Gold (SBGL) holding the old, high-cost South African mines, and the new Gold Fields focusing on faster-growing assets. So far, at least, investors have been unenthused: Gold Fields has dropped 18% since the split occurred on Feb. 11, while Sibanye has fallen 9.4%. Both have been hit by labor unrest in South Africa, unrest unlikely to end soon, considering that unemployment is near 25% and South Africa's mining companies have been talking about downsizing.
The gold-miner selloff, meanwhile, has left many looking cheap—but for good reasons, considering the uncertain outcome of their transformation. Investors willing to take risks should focus on the ones that have low costs, free cash flow—or will have it soon—and operate in more stable countries, says Avy Hirshman, a portfolio manager at Newgate Capital Management. "Today, you need to do your homework and find the ones that have those attributes you feel more comfortable owning," he says.
His favorite: Canada's Yamana Gold (AUY), which operates in Brazil, Chile, Mexico, and Argentina. The company's cost of production is about $500 an ounce, well below South African miners' $800-plus, and it has been cutting its capital expenditures. Yamana had free cash flow from operations of $509 million during 2012's third quarter.
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