SINGAPORE (May 7): Throughout history, one investment has stayed steadfast: gold. Now, as the winds of change rip through geopolitics — with China as a rising power —gold could make a comeback. In our story “China acts to make petro-yuan a reality” (Issue 828, April 30), we pointed out that China is paying for Russian oil in renminbi, which is backed by gold.
Last November, in a little-covered conference titled “Russian Bullion Market”, the BRICS — Brazil, Russia, India, China and South Africa — articulated their intent to start their own gold trading system. Three of the BRICS — China, Russia and South Africa — are among the world’s top gold-producing countries. During the conference, the Bank of Russia signed a memorandum of understanding with China to develop a joint trading system for gold, and the first steps in implementing this project began this year.
The best way to invest in gold is to buy bullion. United Overseas Bank’s main branch in Raffles Place is probably the most reliable way to buy physical gold. Goldheart Bullion also sells physical gold at its retail outlets.
Gold is produced by gold mining companies, of which there are several hundred. According to the World Gold Council, mine exploration requires significant time, financial resources and expertise in many disciplines such as geography, geology, chemistry and engineering. Less than 0.1% of prospected sites will lead to a productive mine. And only 10% of global gold deposits contain sufficient gold to justify further development. Exploration can take up to 10 years before finding a mine that is viable.
Gold mine development is the second stage of the gold mining process. Mining companies must obtain appropriate permits and licences before they can begin construction. This process generally takes a further five years to accomplish.
The whole point of spending time and money exploring and developing a gold mine is so that its useful life can provide as much gold for as long a time as possible. The life of a mine should ideally be 10 to 20 years. This is the mine’s productive life, during which ore is extracted and processed into gold.
Eventually, a gold mine becomes uneconomic to operate and the decommissioning starts. Like coal mining and oil production, the gold company has to monitor the site and rehabilitate it long after the mine stops producing gold.
Thus, investing in gold mining companies is not for the faint-hearted. For investors, the price of gold over the long term seems to have vindicated their investment decisions. The main problem of investing in gold producers is the volatility in the price of gold. If gold prices fall — at a time when the US dollar is rising, for instance — then the market is likely to sell down the producers. A lot of gold production companies are also gold exploration companies.
In 2013, the World Gold Council introduced a new metric to measure the cost of gold production: all-in sustaining costs. AISC include all additional costs that reflect the varying costs of producing gold over the life cycle of a mine.
Most gold mining companies report their AISC in their regular announcements to their exchange. Another metric is the amount of gold the company puts on the market a year. Gold producers will also have stockpiles of gold. And, of course, their earnings are also subject to gold price fluctuations.
The top 10 producers on a trailing 12-month basis were Barrick Gold, Newmont Mining, AngloGold Ashanti, Newcrest Mining, Gold Fields, Agnico Eagle Mining, Sibanye Gold, RandGold Resources, Yamana Gold and Zhaojin Mining, an H-share. China is the world’s largest producer of gold, followed by Australia, the US, Russia and South Africa.
Challenges facing mining companies
TSX- and NYSE-listed Barrick Gold, the world’s largest gold producing company with a 12-month trailing production of 5.32 million ounces, has to keep investing in new mines as old mines deplete. Its AISC for the three months to March 31, 2018 averaged US$804 an ounce versus US$772 a year ago.
The earnings of a gold company can be volatile, depending on corporate action or impairments. For instance, for 1QFY2018, Barrick reported net earnings of US$158 million ($210.8 million), or 14 US cents a share. The company stated that FY2018 production is likely to be between 4.5 million and five million ounces and its AISC for the year is likely to average US$765 to US$815 an ounce. Barrick plans to reduce its debt to US$5 billion for this year, from US$6.42 billion in FY2017 and US$13.1 billion in FY2014.
Its 1QFY2018 net earnings are a sharp decline from its 1QFY2017 earnings of US$679 million. This was largely due to US$1,125 million of net impairment reversals (US$522 million net of tax and non-controlling interest). The write-back was because of a revaluation of the Cerro Casale project as a result of Barrick’s divesting 25% of this project to Goldcorp.
Also, in 1QFY2017, Barrick Gold sold 50% of a mine in Argentina to Shandong Gold Mining Co for US$960 million as a first step in a partnership. This was booked in its 2QFY2017. Thus, this year’s net earnings are unlikely to match last year’s.
The second step in the Shandong Gold partnership is to jointly invest in and explore the the Pascua-Lama deposit. As a third step, both companies will evaluate additional investment opportunities on the highly promising El Indio Gold Belt on the border of Argentina and Chile.
Murky past
Barrick Gold was a familiar name in Southeast Asia in the 1990s when it coveted a share of Bre-X Minerals’ Busang mine. In 1993, Bre-X bought a property in the middle of a jungle near the Busang River in Kalimantan, Indonesia. Initial findings showed that the property contained gold — ironically, the tests were tampered with to indicate that the mine was worth developing. In 1996, the Indonesian government of the day suggested that Bre-X partner with Barrick Gold and the late President Suharto’s offspring to develop the mine, with Freeport-McMoRan Copper & Gold (a unit of NYSE-listed Freeport-McMoRan) managing the mine. In 1997, it was discovered that Busang had no viable gold ore and the saga is still viewed as the greatest mining fraud in history. Barrick Gold was not affected financially, as it had not invested in the joint venture. Shareholders of Bre-X were badly burnt. Its share price had risen from 30 Canadian cents to as high as C$280 before collapsing.
The episode shows that sizeable gold deposits are often in countries where corruption is a way of life. In a post-mortem of Bre-X, which was delisted in 2003, it was found that of the 54 countries where mining takes place, 70% are corrupt.
The challenges of operating in exotic developing countries are apparent from the experience of Toronto-listed Centerra Gold (see chart). This was one of the top six stocks that showed up in our screening. The others were Trans-Siberian Gold, Northern Star Resources, Gran Colombia Gold Corp, OceanaGold Corp and Evolution Mining.
Top stock in our screening owns mines in Kyrgyz Republic and Mongolia
Centerra Gold was in the news recently. In March, it received an unsolicited, non-binding proposal from Kyrgyz-based, AIMS-listed Chaarat Gold Holdings for Centerra’s Kumtor mine, located in the Kyrgyz Republic. Centerra promptly communicated to Chaarat’s advisers that it was not interested in the transaction proposed by Chaarat. In recent meetings with the Kyrgyz Republic government, senior Kyrgyz Republic officials have told Centerra that the government is also not interested in pursuing the transaction proposed by Chaarat. The Kumtor mine transaction proposed by Chaarat could not occur without the participation of both Centerra and the Kyrgyz Republic government, Centerra said.
Centerra Gold is a Canada-based gold mining company focused on operating, developing, exploring and acquiring gold properties in North America, Asia and other regions. Centerra operates two flagship assets — the Kumtor mine in the Kyrgyz Republic and the Mount Milligan mine in British Columbia, Canada. The company registered the highest five-year earnings before interest, taxes, depreciation and amortisation compound annual growth rate in our screening and, like other gold companies with high five-year Ebitda CAGR, its enterprise value-to-Ebitda ratio is in single digits.
Centerra’s Kumtor mine is operational up to 2026 and Mount Milligan, up to 2037. The total proven and probable gold reserves of 16 million ounces in both mines do not include 1.6 million ounces of high-grade underground inferred resources at the Kumtor mine, which also has proven and probable copper reserves of 2,049 million pounds of contained copper.
In addition, Centerra owns exploration properties and joint ventures in Canada, Mexico, Mongolia, Nicaragua, Sweden and Turkey. In 2017, Centerra produced 785,316 ounces of gold at an AISC of US$688 an ounce. Kumtor exceeded its revised gold production guidance and beat its cost guidance, delivering 562,749 ounces of gold production at an AISC of US$698 per ounce sold. Mount Milligan met its cost guidance AISC of US$505 per ounce sold but fell short of its gold production guidance.
In 1Q2018, Centerra had to close Mount Milligan’s mill, owing to a shortage of fresh reclaim. This will affect the mine’s production, but it is expected to return to full capacity in 2Q2018.
Separately, in 1Q2018 Centerra acquired a Canada-listed gold investment company, AuRico Metals, which was subsequently delisted. This company owns a free-cash-flow-generating royalty portfolio that includes a gold mine in Australia and in Ontario, Canada.
For FY2017, Centerra reported net earnings of C$209.5 million ($218 million), or 72 Canadian cents a share. The company generated cash flow of C$501 million, or C$1.72 a share. The Kumtor mine generated C$188 million of free cash flow, driven by a higher gold output. The Mount Milligan mine generated free cash flow of C$127 million, reflecting a full year of production. At end-2017, the company reported C$417 million of cash, cash equivalents, restricted cash and short-term investments, ending the year in a net-cash position of C$119 million.
An impairment charge was taken on Centerra’s Mongolian assets. It reduced the carrying value of the mine by C$41.3 million to C$60 million, owing to new results from technical and economic studies.
Owning a mine in an exotic location requires good rapport with the country’s government. Last September, Centerra reached a comprehensive settlement with the Kyrgyz government to resolve all of the outstanding matters affecting the Kumtor project. The settlement included a one-time lump sum contribution of C$50 million to a Kyrgyz government-administered Nature Development Fund. The contribution resulted in the lifting of restrictions on the freedom of movement of Kumtor employees and the ability of Kumtor to distribute funds to Centerra.
Safe and sound
Australia-based and ASX-listed Northern Star appears to be the safest bet, with its Australia-based mines. It generated free cash flow of A$32 million ($32.06 million) in the March quarter, leaving it with cash and equivalents of A$439.1 million and no debt as at March 31, 2018. The company announced that it had completed the capital expenditure required to reach its production target of 600,000 ounces a year by the three months to June 30.
“The combination of this increased production, low operating costs and completion of the capital investment programme will drive free cash flow significantly higher. Northern Star has narrowed its FY2018 guidance to 540,000 ounces to 560,000 ounces, which is well within its previous range of 525,000 ounces to 575,000 ounces. The forecast for AISC is unchanged at A$1,000 to A$1,050 an ounce,” Northern Star says in its latest earnings announcement. In FY2017, the company produced 514,735 ounces of gold from its Jundee, Kalgoorlie and Paulsens operations.
In the meantime, the company sold 119,976 ounces of gold at an AISC of A$1,075 an ounce for the three months to March 31, taking the total for the nine months to March 31 to 387,254 ounces at an AISC of A$1,053 an ounce. Northern Star has a June year-end.
The company’s reserve base tripled to 3.5 million ounces as at March 31, and its resources stand at 10.2 million ounces. It now has 10 years of mine life visibility, based on the operations of its Jundee and Kalgoorlie mines. The company forecasts a production of 550,000 to 600,000 ounces for the year to June 30, 2019.
Northern Star now ranks as the third-largest Australian gold producer and it continues to advance its activities at the Central Tanami Project in the Northern Territory. For 1HFY2018, Northern Star’s revenues rose 5% y-o-y to A$435.3 million, but net profit fell 24% to A$79 million.
