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Alex Létourneau

Outlook 2013: Gold-Mining Stocks Expected To Rise As Companies Reduce Costs

By Alex Létourneau of Kitco News
Friday December 28, 2012 10:28 AM

(Kitco News) - Gold-mining stocks were generally considered undervalued during 2012 but that trend is expected to change in 2013 as mining companies are expected to bring down production costs.

“They’re going higher,” said Rob McEwen, chairman and chief executive officer of McEwen Mining Inc. (TSX, NYSE: MUX). “You can look all around the industry, there are huge cost overruns and again that’s part of the disappointment investors have due to the estimates that bear no reality to the reality.

“You also have a lot of big projects that are coming to an end and with the deferral of projects there’s not the same demand for drills and large process plants so delivery times are getting shorter, availability has been improved dramatically in the drilling space, demand for consultants has begun to fall back,” said McEwen.

The mining industry boomed over the last few years, and growth was not limited to gold mining.

“All the stocks have been underperforming because they’ve all been struggling with tremendous rises in costs,” said Joe Foster, portfolio manager of the Van Eck gold fund.  “There’s been a labor shortage (and) a mining boom around the world so the gold companies are competing with iron ore producers, base metals producers and the tar sands producers and everybody else, they’re all competing for the same equipment and labor.”

The Financial Post reported Caterpillar Inc. (NYSE: CAT), an earth-moving equipment manufacturer, said in October that backlogged orders have dropped $5 billion in three months and new orders were declining significantly.

“Across the industry costs have gone up much more dramatically than anybody would have guessed over the last two years and that’s caused the entire sector to underperform,” said Foster. “So what I’m saying is the escalation of the last two years is about to make a turn for the better in 2013 and that’s going to enable a lot of companies to outperform gold.”

Cost overruns have become somewhat rampant within the mining industry. One of the most reported examples of enormous cost rises is Barrick Gold Corp’s (TSX, NYSE: ABX) Pascua-Lama project in Argentina.

The costs of building the mine, which will produce 800,000 to 850,000 ounces of gold and 35 million ounces of silver over the first five years of its 25-year mine life beginning in late 2014, have soared to $8.5 billion. In 2009, mine-construction costs were estimated at $3 billion. Initially Pascua-Lama was expected to cost roughly $1 billion in 1997 to build.

“Pascua Lama is one of many projects that have gone way over budget and I think it’s been the rush to develop projects,” said McEwen. “And along with the shortage of senior talent, the shortage of the near-term inputs going into the mining industry, there’s been a lot of money brought to the industry wanting exposure to metals and the industry started to accommodate by building them fast but the costs have escalated faster than anyone would have anticipated.”

Large-cap stocks have suffered from these cost hikes and in turn have underperformed when compared to gold.

“Every year there have been a few stocks that have underperformed and mainly it’s been the large-cap stocks, so if you look at an index like the XAU that’s dominated by the large caps like Barrick, Newmont and AngloGold, that index underperforms gold most of the time because of those large cap stocks,” Foster said. “They have difficulty growing; there (are) some fundamental problems within those companies to underperform.”

“The XAU has outperformed gold by a factor of four since about ’09-’10,” McEwen said. “There was a very close relationship and then there was a breakdown that may have been brought about by the poor performance of the seniors in terms of corporate governance.  

“There were some very large expenditures in areas that the market wasn’t expecting; Barrick buying Equinox, Kinross going into Africa and other ones that just threw people off,” said McEwen. “So right now it appears to be much cheaper to buy gold in the ground owned by a public mining company then buying it a vault or an ETF or even through a gold royalty.”

While mitigating mining costs are seen as a major factor to a rise in gold stocks in 2013, there are other indicators that could push them higher.

“Something that I think is very interesting right now that we’re seeing which is going to be a shift in the next year or so is decoupling,” said Jordan Roy-Byrne, editor and publisher at The Daily Gold newsletter. “If you look back to the end of last year we saw the start of a decoupling in terms of the general market and the gold stocks, and to a smaller degree, gold and silver also because they peaked before the market did.

“If you look now, the S&P is rallying pretty close the high of this cyclical bull market at the same gold stocks made that strong double bottom earlier this year and now they’ve retraced a large percentage of that,” Roy-Byrne said. “So when you consider those things it’s pretty obvious you had a decoupling, they’re trending in a different direction.”

Roy-Byrne sees similarities between what is currently happening in the markets and a five-year period in the early to mid-1970s.

“If you actually go back to the 70’s, from 1972 to 1977, the market and gold stocks were trending in different directions so I think we could be seeing something similar to that,” Roy-Byrne said. “What that means is for gold stocks to move higher, we’re going to have to see worse economic news because that will induce more stimulus, monetization and that sort of thing. The economy is really stagnant, will probably get worse and if you look at what’s been happening with a lot of these markets is that they’ve been trending higher.

“If gold stocks make a strong bottom here and they confirm that double bottom sometime in the next month or two and we see the economy get worse and conventional investments struggle, then I think you’re going to see gold stocks have a very good year which I do believe is more likely than the other scenario, where things just remain stagnant and sort of plod along for most of the year.”

McEwen also points to past trends that he believes will push gold stocks higher in 2013. McEwen refers to a four-year trend that has taken place since 1984 involving the U.S. presidential election.

“It seems that every four years during the presidential elections in the U.S., that the year of the election, using a time series of seven elections starting in 1984, that the XAU has declined in value during that election year and recovered almost completely by the end of the following year,” McEwen said. “If you think about it during the election year, the incumbent party is out there making new promises telling the world what they’ve done is lay the groundwork for a better economy in the future and they should be reelected to complete the plan.”

McEwen said that the following year reality strikes and people come to the realization that the economy is not recovering as fast as everyone had hoped for, the promises are slower incoming and big economic issues have not been resolved yet.

Foster doesn’t believe the presidential election will drive gold stocks higher but he does agree that they will be going up in 2013.

“I don’t see any reason why there would be a correlation between presidential elections and gold stocks are doing, I mean, we just look at the fundamentals,” said Foster. “The reason I think gold stocks will outperform is because what’s been driving their underperformance has been rising costs and their failure to meet expectations.

“I’m expecting them to get their costs under control in 2013 and I’m expecting them to do a better job of meeting expectations, and that should allow the stocks to outperform.”

By Alex Létourneau of Kitco News aletourneau@kitco.com

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 precious metal products, 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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