Gusto for Gold Mines

It’s been a good year for gold. Gold spot prices hit $1,360 per ounce in early August, up 28% percent since the beginning of the year, buoyed by low interest rates and more recently, demand from investors seeking a safe haven from Brexit-related economic uncertainty. But for equities-minded investors, it’s worth considering the miners behind the metal. Gains by gold mining stocks have outpaced those of gold prices, with the NYSE Arca Gold Miners Index up more than 125% percent year-to-date, and Credit Suisse team believes there’s good reason for the gold mining rally to keep rolling.

In short, the industry has learned from its mistakes.   The last time we saw a surge in gold prices like this one was in the summer of 2011, when gold shot up from below $1,600 in June to a record $1,910 per ounce that August. It was the last leg of a years-long gold rally that started during the financial crisis in 2008. Mining companies, which hadn’t enjoyed such attention from investors since 1980, threw caution to the wind and began operating under the assumption that the high prices were going to last a while. In particular, they expanded production to low-grade mining projects that would only be profitable if gold prices stayed aloft. 

Then the bottom dropped out. In 2013, gold prices began a steep decline, those low-grade projects turned into money pits, and companies were forced to suspend operations everywhere from South Africa to New Zealand. Many gold miners still “suffer from a bad reputation for destroying capital,” says Dan Scott, a senior research analyst with the Bank’s IS&P team.   Conflicts with national governments over environmental concerns haven’t helped. In 2013, Chilean authorities ordered Barrick Gold, a Canadian firm, to suspend operations at its Pascua-Luma mining project on the Chile-Argentina border for flouting environmental regulations. Barrick ultimately declared a $6 billion loss on the project. That same year, British mining giant Anglo American pulled out of a project in Alaska’s Bristol Bay after the U.S. Environmental Protection Agency issued a report detailing how mining activity could harm the area’s wildlife, raising concerns that the agency would eventually block the project. The stakes were high enough that Anglo American walked away from the more than $500 million it had spent to develop the site, which continues under the aegis of Canadian mining company Northern Dynasty Minerals.   So what’s changed? 

The financial health of gold miners is demonstrably better today than it was just three years ago. Following the drop in gold prices, the industry moved aggressively to slash costs, including cuts to capital expenditures, exploration budgets, and overhead operating costs. All-told, the industry’s “all-in sustaining costs”—a measure of mining efficiency that takes into account the price of exploration projects as well as the cost of production—have dropped as much as 30 percent since 2013. Having revamped itself to ensure it could survive gold prices as low as $1,000 per ounce, the industry is now enjoying prices above $1,300, and today’s leaner mining companies are throwing off rising levels of free cash flow.   The Bank’s IS&P team believes gold miners have learned from the past and will continue to exercise tight fiscal discipline. Scott says macroeconomic uncertainty will encourage miners to keep their focus on high-grade ore to limit production costs, and that they’ll likely continue deferring capital expenditures as well. A more conservative approach to new projects should also constrain gold supply, providing more support to gold prices.   And those are just the things under their control. Factors outside the mining industry may fuel further price increases, such as a Brexit-borne European or global economic slowdown that sends investors scurrying to safe havens. Any delays in interest rate hikes by the Federal Reserve could also bolster the yellow metal. Credit Suisse’s Global Markets team expects gold prices to rise to $1,500 per ounce by the first quarter of 2017. For the gold mining industry, it’s all just icing on a very shiny cake.