Gold Companies Still Face Cost Squeeze

The vaunted leverage of gold producers to gold hasn't worked out very well this decade, and rising costs are to blame. This year, gold producers have seen a satisfying surge in profits but the stock prices haven't surged along with their earnings. Alix Steel explains why in this report for the Street.com, in which she discloses that most producer CEOs are still facing about cost squeezes.

The chief executive officers of major gold mining operations have gathered here this week for the BMO Capital Markets 20th Global Metals & Mining conference. Many will be taking time out of the conference to meet with TheStreet to discuss the headwinds their companies are facing this year, which include rising raw material costs, higher labor pay, escalating taxes and exchange rate problems.

Many of these executives have recently reported strong fourth-quarter earnings results that were largely fueled by gold prices hitting a record 2010 intra-day high of $1,432.50 an ounce. While good news for investors, the dominant theme that emerged from those results centered around the rising battle between higher revenues and steeper input costs. In fact, Barrick Gold and Goldcorp seem to be among the few exceptions that have minimal exposure to the issue.

She ends her article with these useful words for any prospective gold-stock investor:

For an investor wanting to buy gold stocks , it can be a risky endeavor. The nuts and bolts of traditional financial results like earnings per share are less important than in other sectors. Instead, it's best to focus on how much gold the company has in the ground, how much it will produce, for how long and at what costs. We'll put these questions to the CEOs to determine the winners and losers of 2011. Stay tuned.

I once did a long-term number crunch on how much beta (leverage) the Amex Gold BUGS Index had to gold itself. The figure I got was about 1.67. Interestingly, the BUGS has next to no alpha: there was no risk-adjusted benefit to investing in gold stocks vis-a-vis gold itself. That lack of alpha, along with the greater number of uncertainties that come with investing in gold miners, may explain why most hedge funds have tended to go with bulllion.

Vietnamese Dong Gets Boost From Controls

Following up on yesterday's announcement of a coming ban on gold trading, the Vietnamese government has ordered firms to dump U.S. dollars on the market. The dong got a boost from greenbacks being sold as a result of the new controls being put in place.

Vietnam’s dong strengthened at banks and money changers after the central bank said dollar supply increased following an order for companies to sell more of the U.S. currency back to lenders.

Both the dollar sales and gold controls are designed to address the fall of the dong and to divert economic activity from what the authorities consider to be unproductive speculation.

ISM Index Up, Construction Spending Down

Two gauges of the U.S. economy were released at 10:00, and both highlight different sectors with different fortunes. The ISM survey of manufacturing yielded a number of 61.4% for February. It's at its highest level since May of 2004, and signals expansion because it's over 50%. The manufacturing sector has enjoyed 19 straight months of growth - not bad for a sector that was largely overlooked last decade.

With less hope comes an estimate of U.S. construction spending, which fell 0.7% on January. Of some consolation was it beating expectations for -1.6%.


Gold didn't react very well to the data, which amplified a pullback to $1,420. Just before the release, the metal had recovered from a deeper downturn to reach $1,425.

SPDR Gold Shares Trust Holdings Down For Fifth Month In A Row

February hasn't been a good month for the SPDR Gold Shares Trust (GLD), depite gold's recovery during that period. For the fifth month in a row, its holdings have declined.

"The most popular of the ETFs has for quite some time been seeing falling stocks and at the weekend these, at 1,218 tonnes, were at their lowest levels in almost nine months," said precious metals house Heraeus in a weekly report.

"Whether this is an appetiser for larger profit-taking to come is not clear, but the question is fairly important as this largest ETF, the SPDR Gold Trust, holds almost seven times more metal than the second largest one."

Thankfully, physical demand and (more recently) futures demand have taken up the slack. Gold hasn't fallen that much, even at its worst, as a result of those other demand sources ramping up.

Guide To Finding Junior Gold (And Oil) Companies

"The Patient Investor" has spent some time investing in junior resource stocks. He's been involved with VSE-listed stocks as far back as the 1980s, when the Venture was still the Vancouver Stock Exchange. And, he's written a guide explaining what he looks for in a junior. Included is his procedure for finding American quotes for Canadain-listed stocks. Of note is the fact that he uses management presentations not for selection, but for elimination.

As for golds, he uses these criteria:

What do I look for in companies? I want multiple projects with large land areas, a high amount of resource, experienced management, low number of shares, and in a good location.

For gold mining companies with open pit heap leaching projects, I want at least a million ounces of gold reserves and production of 75,000 ounces of gold a year. In third world countries I want at least 50 million tons of ore at .8 grams of gold a ton. In the US or Canada, I want 50 million tons of ore at 1.2 grams of gold a ton. For underground mines with a milling operation, I want at least 1.5 million ounces of gold reserves and production of 100,000 ounces of gold a year. I want at least 20 million tons of ore at 6 grams per ton in third world countries. In the US or Canada, I want 20 million tons of ore at 8 grams a ton. If a US or Canadian company produces much more gold a year and has much larger reserves, I will look at a little lower grams per ton.

The reason for wanting higher grade ore in the US and Canada is higher labor and operating costs. Also, if the company is producing other metals as part of its operations, then a lower grade of gold ore can still be very profitable. The reason I want more production in an underground mine and milling operation is it usually costs much more to produce an once of gold than in an open pit heap leach mine. I usually try to invest in these companies once they have raised money to bring a mine into production or after the scoping/feasibility report is finished.

That point is where a patient investor would step in. Often, exploration stocks on the verge of production drift listlessly for what seems to be a very long time. From what I've seen, the rewards for this strategy are greatest at about the time a good or very good feasibility study is released. Of course, the risks are greatest at that point - and that's because the big barrier is still acquiring capital for the project. Companies that don't secure capital have a tendency to drop to near-zero if they're indebted. If not, they still sink and go dormant indefinitely.

Should they get financing or taken over, on the other hand, then they climb and sometimes shoot up.

One exception to this rule are hot companies whose flagship projects contain huge deposits. They tend to be shoot up long before the feasibility study, in part of hopes of a takeover by a major. One more wrinkle: a company with a hot strike tends to leap up beyond the price that later economics justify.

The best entry point for risk-takers is before the feasibility study if the stock has been listless for a long time. A good sign for those less adventurous is a jump in the stock price once the feasibility study is released.

Still, there's the capital barrier to remember.


An example of an advanced-stage exploration company with a good preliminary economic assessment, which is two steps away from a feasibility study, is Majestic Gold Corp. I've profiled it here. Unfortunately, Majestic does not qualify on the low-shares criterion but the projected economics of its project are fairly good.

Indian Physical Gold Buying Climbs On Firm Rupee

According to a Reuters India report, gold buying increased because of slightly lower gold prices last night and a firm rupee.

"There are good deals at $1,413 (an ounce), we priced in for 120 kgs of gold," said a dealer with a state-run bullion dealing bank.

Also adding to demand is harvest and wedding season, both underway now.

Gold, After Slow Rise, Breaks Above $1,420

There wasn't much news on the usual fronts to get gold excited enough to ford above $1,420, but it did so after breaking through $1,415 around 6 AM ET. Prior to that breakout, the metal sunk a little on news that the Australian central bank is leaving its key rate unchanged at 4.75% because of easing inflation pressures. Bottoming at a little below $1,410 on the news, gold later shook off the drop and trudged back up to where it closed yesterday. Continuing to inch up after night turned into morning, it bumped against $1,415 before retreating. On the next try, at 6:00, it succeeded. The momentum encouraged technical buying that lifted it above $1,420 just before 8:00. As of 8:08 AM ET, the spot price was $1,421.70 for a gain of $10.50 on the day. The Kitco Gold Index split the gain into +$9.65 due to predominant buying and +$0.85 due to a weakening of the greenback.

The U.S. Dollar Index spent overnight fluctuating between 76.75 and 77.0, with a brief dip below the lower level just before 5:40 AM. Mostly rising upwards overnight after a drop in early evening, the Index was blocked from further rises at the 77.0 level and fell back down to the low end of the range. 76.75 holding, it rebounded to 76.9 but only temporarily. As of 8:14, it was at 76.83.

A Bloomberg report credits Libyan unrest and a weaker greenback for gold's jump. Adding to the former is the prospect for outside intervention to the rebels' benefit.

“Prices are up as the dollar weakens slightly and concerns remain that unrest in the Middle East could lead to more significant protests,” John Meyer, an analyst at Fairfax IS in London, wrote in a report today....

Gold and silver “are set for further gains as ongoing Middle East and North Africa turmoil continues to draw strong investment and flight-to-safety demand,” James Moore, an analyst at TheBullionDesk.com in London, said today in a report.

The article also notes that the holdings of ten gold ETFs tracked by Bloomberg rose again yesterday, by 0.84 tonnes to 2,012.16 tonnes.

A Reuters report, written before the break above $1,415, said the Mideast and North African turmoil overpowered good U.S. economic data to keep gold up.

"We were looking for a correction in gold in January, and certainly I think that correction was interrupted by the political situation in North Africa and the Middle East, and that has been responsible for getting gold back up to $1,400,"
said Deutsche Bank analyst Daniel Brebner.

While the uncertainty over the region is proving beneficial for gold for now, Fed Chairman Ben Bernanke's twice-yearly testimony to the U.S. Senate Banking Committee later in the day could be more decisive in determining the outlook for the gold price, he said.

"The market may look at Bernanke's discussion today to get guidance in terms of where the next move will be. If it is to remain accommodative, then that's very good for gold. If the Fed ... talks about a hiking cycle or rising interest rates, then
that may temper enthusiasm."...

"There's conflicting signals out there, which is beneficial for gold. But I wouldn't say there's a clear direction at the moment. The pendulum has swung back from (investors) being optimistic about economic recovery to being somewhat more cautious," said Simon Weeks, head of precious metals at Bank of Nova Scotia.

Part of that ambiguity is reflected in rising open interest on gold contracts while holdings of the SPDR Gold Shares Trust are still declining. Yesterday, its holdings dropped 0.61 tonnes to 1,210.96 tonnes. On the bearish side, the Australian Bureau of Agricultural and Resource Economics and Sciences opined that gold could drop 20% as speculators exit the market due to global recovery.

A weaker dollar and Mideast/North African turmoil was also the reason given by the morning Wall Street Journal article, which covers the jump above $1,420. Injecting in some caution, the article notes that some traders think that gold may pause before any test of its record high.

"The price of gold rose 6% in February and normally, after a move of that size, you would expect a period of consolidation," said GoldCore director Mark O'Byrne, adding that buying has been "tentative" for the past week.

However, gold's medium- to long-term prospects remain sound, and GoldCore's target price of $1,500 a troy ounce this year still looks "very likely," said O'Byrne.

It also calls attention to Ben Bernanke's Congressional testimony today and tomorrow.

No news on the U.S. economy was slated for the 8:3o slot, so gold's pullback to $1420 wasn't influenced by any good news or otherwise. Bottoming at that level, it inched up at that same 8:30. As of 8:40, the spot price was $1,420.60 for a gain of $9.40 on the day. The Kitco Gold Index divided the gain into +$9.10 for predominant buying and +$0.30 for greenback weakening. The U.S. Dollar Index, after falling until just before 8:30, inched back up; as of 8:45, it was at 76.90.

Gold's jump above $1,415 preceded a take-out of $1,420, but its action has been indecisive above that level. It may not stay that high as the day unfolds. But, its pressing against the high end of the $1,400-$1,420 interday range is encouraging. The market seems to think that any surprise coming from Bernanke's testimony today and tomorrow will be unfavourable for gold, suggesting a healthy skepticism still exists. If gold keeps rallying today, it would be a pleasant surprise.