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SWOT Analysis: Will Gold Miners See A Boost in Free Cash Flow?

Commentaries & Views

Strengths

  • The best performing metal this week was palladium, up 2.14 percent. Physical demand is tight as holdings in metal backed ETFs are being withdrawn and then lent to users as one-week lease rates are currently at 5 percent, higher than Treasury yields. Gold is set for its first weekly gain in a month as the dollar fell amid speculation that the Fed might be less aggressive in raising interest rates than expected, writes Bloomberg.
  • U.S. consumer prices rose by 0.2 percent in April, less than forecasted after a March decline of 0.1 percent, as measured by the consumer price index. Bloomberg writes that used car prices saw their biggest monthly drop since 2009 and airline tickets also fell the most in four years. Naeem Aslam, chief market analyst at TF Global Markets said that they “do not expect the Fed to remain hawkish when it comes to interest rate hikes.”
  • UBS writes that the gold consolidation could continue for now amid a stronger U.S. dollar. Positioning in gold has been cut significantly in the last couple of weeks and last week’s data shows net longs at 35 percent of the all-time high. Joni Teves, UBS strategist, writes that “this is understandable after gold remains capped, failing its attempt to break the $1,350/$1,360 level in April.”

Weaknesses

  • The worst performing metal this week was gold, up 0.22 percent. Randgold Resources Ltd. fell to its lowest in 18 months after a labor dispute at its Tongon mine in Ivory Cost will likely prevent the mine from hitting its full-year target, reports Bloomberg. Randgold’s new mine in the Democratic Republic of Congo faces challenges over a new mining code that could threaten profits. Kinross fell 5.3 percent in pre-market on Wednesday after Mauritania rejected one of its exploitation permits for failure to meet feasibility criteria.
  • Newmont Mining’s chief economist Tom Brady gave a presentation at the Mines and Money Conference in New York this week saying that investors continue to favor gold versus gold equities. Brady stated that gold miners have seen “anemic returns” and that ore grades have fallen around 35 percent in the past 20 years. Brady also spoke about senior gold producers reducing debt recently, but that total debt was still around $25 billion in 2017, compared with less than $4 billion in 2000.
  • Bloomberg reports that China’s foreign-currency stockpile, the world’s largest such stockpile, fell $18 billion to a five-month low of $3.12 trillion last month. This is the second monthly shrinkage this year and is likely due to a stronger U.S. dollar. Several large corporations such as Apple, Netflix and Microsoft are no longer reporting on their cash held overseas. This lack of disclosure makes it difficult to calculate whether or not the new tax reform is having an effect on bringing cash held overseas back to the States. With the recent broad market weakness over the last couple months, the surge in the U.S. dollar may only reflect money being brought back to the States to execute stock buybacks as if trying to put a floor on falling technology shares and may not be a fundamental sustaining force for the value of the dollar.

Opportunities

  • Epsilon Theory published a report analyzing Bloomberg articles that contain material related to inflation and their sentiment. The study found that from April 2016 to March 2017 there were 1,400 articles published about inflation with most of those referring to inflation as a subsidiary topic. From April 2017 to March 2018, by contrast, there were 2,400 articles published where inflation was mentioned, with the majority of them actually being about inflation. The researchers suggest that because inflation was written about more and had a more cohesive narrative; it became common knowledge and accepted that inflation is indeed rising. 
  • Matthew Sigel of CLSA wrote about two reports this week showing how inflation can rise due to changes in demographics. One report documents the stagnation in real wages that occurred from the 1980s to 2000s when manufacturing surged in Asia after China and Eastern Europe were brought into the World Trade Organization, however the wage stagnation is now reversing due to aging populations and rising real interest rates. Sigel also notes how the second report prepared by the Bank of International Settlements connects age demographics and dependents. The author specifically concludes that inflationary pressures rise when the share of dependents increases and, conversely, subsides when the share of working age population increases.  Their data predicts rising inflation over the coming decades, which has historically been good for gold.

JPMorgan CEO says growth and inflation may push 10-year yields back to 4 percent

  • Eily Ong, Bloomberg Intelligence industry analyst, writes that gold production growth will likely slow as a result of falling weighted-average gold reserve grades. Mine life expectancy has declined since 2012 and expectations are that major gold miners may exhaust their current mines’ lives within 19 years versus 25 years in 2012. Ong writes that overall capital spending could drop for gold miners and boost free cash flow to a new record.   Falling production and more free cash flow should make way for more mergers and acquisitions as the gold price climbs with rising inflation expectations.

Threats

  • South Africa’s National Union of Mineworkers (NUM) has submitted wage hike demands in the gold sector of up to 37 percent over a two-year period, reports CNBC.  According to a document submitted to the Chamber of Mines, the demands far exceed the current inflation rate of 3.8 percent and suggest potentially tough negotiations with companies that have tried to contain these rising costs in the world’s deepest mines, the article continues. On a similar note, South Africa’s Solidarity Union says that it wants annual pay increases of at least 10 percent from gold-mining companies, reports Bloomberg, as it prepares for the next round of wage negotiations.
  • As supply risks in Venezuela and Iran strain global markets, Bank of America Corp. says that oil prices could rally to $100 a barrel in 2019. “Brent futures, trading near $77 on Thursday, are set to reach $90 in the second quarter of 2019 as world inventories shrink,” the bank said. So what does this mean for gold? If oil prices go up too much, gold mining companies’ margins will be compressed, which is a threat to the industry.
  • Barrick Gold has entered into a subscription agreement to acquire 46.6 common shares of Midas Gold at C$1.06 per share, reports Bloomberg, resulting in Barrick owning about 19.9 percent of Midas.  Using a replicating portfolio valuation of other gold mines currently in production of known ounces and grades, the $970 million initial capital expenditure to build the Stibnite Mine implies that about 16 million ounces of gold-equivalent production from the mine would be needed to support the investment.  Stibnite currently has 6.4 million gold-equivalent ounces of resources but it is not uncommon for a typical gold mine to produce more than 2x the number of gold ounces on the resource statement over the life of the mins as new ounces are found and incorporated into the mine plan.
Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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