Barrick Gold Corp. (ABX) and other bullion producers are climbing from 28-year lows relative to the metal as they tame costs, raise cash flow and beat profit estimates.
Share-valuation measures have improved since mid-year, suggesting a return of optimism regarding the sector, Kenneth Hoffman, a Bloomberg Industries analyst, said in an Oct. 29 report. Goldcorp Inc. (G) and Agnico-Eagle Mines Ltd. (AEM) rose the most in almost five months after their earnings last week beat analysts’ forecasts. Barrick, the world’s largest producer, reports results tomorrow.
“The gold shares are starting to outperform the gold price,” David Christensen, chief executive officer of ASA Ltd. a San Mateo, California-based company that manages about $550 million and invests in precious metals companies. “As the companies begin to tighten their operating constraints and generate more cash flow, we’re seeing some of that turnaround in the valuations in the industry.”
The 56-company S&P/TSX Global Gold Index (SPTSGD) has gained 12 percent since June 30 through yesterday, compared with a 6.7 percent increase in the S&P/TSX Composite Index. Gold futures in New York have risen 6.7 percent in the same period.
The gain is a reversal from the past two years when equities underperformed relative to the metal and the broader market as investors bought exchange-traded bullion funds for exposure to the metal’s 11-year rise, while producers battled surging costs to build and operate mines. Companies responded by focusing on improving profits and cash flow instead of just growing output, which is helping valuations, Christensen said by phone Oct. 29.
The 30-company Philadelphia Stock Exchange Gold and Silver Index is near a 28-year low relative to gold, Hoffman said Oct. 29. Inflection points in stock cycles have historically occurred when the ratio trades above or below two standard deviations or more from the normal relationship, a situation that is occurring for only the fourth time in the past three decades, he said.
“At a certain point, those equity investors would realize, ‘Hey, things aren’t as bad as we thought,’” Hoffman said in a phone interview from Skillman, New Jersey. “All of a sudden, once the equities start performing better and better, they really take off.”
The average trailing 12-month cash flow per share of the eight Canadian gold producers valued at more than $5 billion has more than doubled in the past two years, to $2.13.
“I believe we’ve passed that inflection point,” Yamana Gold Inc. (YRI) Chief Executive Officer Peter Marrone said by phone Oct. 29 from Toronto. “The companies that are demonstrating cash-flow generation — sustainability of cash flow and an increase in cash flow — those companies in this sector,” will outperform the metal.
Yamana, which this week also reported third-quarter earnings and production that beat analysts’ estimates, has gained 24 percent since June 30. Its shares rose six cents to C$19.54 at 10:06 a.m. in Toronto today.
Barrick will report third-quarter earnings excluding one- time items of 99 cents a share, according to the average of 23 estimates compiled by Bloomberg. The Toronto-based company is reviewing its assets and will be more disciplined in allocating capital and focus on returns and cash flow, Chief Executive Officer Jamie Sokalsky said July 26. Barrick warned at the time that its Pascua-Lama project on the Chile-Argentina border may cost as much as 60 percent more than previous estimates and start up a year later.
Andy Lloyd, a spokesman for Barrick in Toronto, declined to comment for this story. The company’s shares were little changed at C$40.38 today.
There’s potential for Barrick to beat estimates for the third-quarter because of improvements at mines in Nevada and Peru, Stephen Walker, a Toronto-based analyst at RBC Capital Markets, said in an Oct. 29 note. Walker estimates Barrick produced 1.97 million ounces of gold in the quarter, compared with 1.93 million a year earlier.
Newmont Mining Corp. (NEM), the second-largest producer by sales, is scheduled to report third-quarter results after the close of regular trading tomorrow. The Greenwood Village, Colorado-based company is estimated to post profit excluding one-time items of 89 cents a share on sales of $2.52 billion.
Barrick “should come out with a reasonably decent quarter,” Charles Oliver, who manages the C$475 million ($475.3 million) Sprott Gold and Precious Metals fund for Sprott Asset Management Inc., said by phone from Toronto Oct. 19. “I would imagine that they’ve put the worst behind them.”
The ratio of enterprise value to earnings before interest, tax, depreciation and amortization for the current year for companies in the Philadelphia index rose 61 percent to 8.58 yesterday from a low on May 15. The average price-to-book ratio has increased 26 percent since reaching a three-year low on July 24. Enterprise value is market capitalization, preferred equity and interest-bearing debt, minus cash and equivalents.
Producers also may benefit from a slowdown in the cost inflation that has plagued the industry. The average cost per ounce of gold for large producers has risen for nine consecutive years and increased 18 percent in 2011 to $547, according to data compiled by Bloomberg.
Costs will probably increase at a more “moderate” pace as mining projects around the world are shelved or delayed, Goldcorp CEO Chuck Jeannes said in an Oct. 25 interview from Vancouver. Goldcorp rose 13 cents to C$45.42 today.
To be sure, just because gold miners are focused on improving cash flow, there’s no guarantee they’ll succeed or that valuations will improve, Peter Ward, New York-based analyst at Jefferies Group Inc., said in a note Oct. 19. Gold mining is a “very tough business”, he said.
“From our perspective, the luster of gold equities is gone,” Ward said. “In our opinion, the current multiples still do not reflect the likely low returns, paltry free cash flow, high risks and relatively short reserve lives of the gold miners.”
It may take some time for the shift toward better returns and more measured growth to produce significant change in the industry, Agnico-Eagle Chief Executive Officer Sean Boyd said by phone Oct. 25. Most companies are working through budgeting and long-term planning processes at this time of the year, he said. Boyd expects gold equities will continue to outperform the metal.
“They have underperformed for so long, it really begs the question, How bad can it get?,” said Bloomberg Industries’ Hoffman. “Standard-deviation wise, this is historically about as bad as it gets.”
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