NEW YORK (ResourceInvestor.com) -- The gold industry is about to complete its fourteenth quarter in the current gold bull cycle. At the start of the cycle conventional wisdom predicted that nimble intermediate miners with unhedged gold production would handsomely outperform the lumbering mega producers, especially those with ounces sold forward.
It is still far too early to write definitive conclusions until the gold cycle is complete. Nevertheless, we have sufficient data to hand for this cycle, and the modern era as a whole, to poke and prod at core assumptions.
We compared the "Three Amigos" - Goldcorp [GG], Agnico-Eagle [AEM] and Meridian Gold [MDG] - with the "Top Guns" - Newmont [NEM], AngloGold [AU], Barrick Gold [ABX]. Meridian is the only hedger among the Amigos (silver only), whilst only Newmont among the Top Guns has reduced its hedges to negligible levels.
The most surprising trend over the previous eighteen quarters is a very narrow spread in the net margin per ounce of gold mined. Since the March quarter of 2000 the Amigos have only squeezed $3 per ounce more per ounce of gold sold than the Top Guns at $49/oz and $46/oz respectively. The picture changes from the third quarter of 2001 though. That was the first full quarter of higher gold prices after a long decline. Until the second quarter of 2004 the Amigos outperformed the Top Guns by $12/oz at $86/oz and $74/oz respectively.
The increased margin is expected in the circumstances, but it is surprisingly tame. Margins are not as strongly correlated to rising gold prices as was expected even though the Amigos went into the cycle unhedged. Indeed, there are substantial periods where the Top Guns have actually managed to wring more profits from each ounce mined than the Amigos. Absent some write downs the record would have been ever better.
A $12/oz opportunity cost is not insignificant though when it is put in a production and time context.
Since the 2001 September quarter the Top Guns have produced 55.9 million ounces of gold. That means they surrendered around $675 million over 12 quarters, or $56 million per quarter based on the $12/oz shortfall. That is a whopping 9% of average aggregate quarterly EBITDA over that period, and altogether enough to pay for a sizeable new mine. For example, it would probably buy a 60,000 tonne per day operation at Las Cristinas producing over half a million ounces of gold every year.
Some of the gap is certainly attributable to hedging because Top Gun aggregate revenue has been largely unresponsive to changes in production and the gold price. Revenue and EBITDA have in fact underperformed the gold price on a relative basis which underscores the impact of hedging. (See chart 2 & 3)
The flip side is that the Top Guns have enjoyed the ability to suppress cost inflation better than the Amigos. If anything, the Top Guns are surprisingly competitive in terms of total production costs given their larger overheads. Consequently we cannot be sure that without hedging the Top Guns would have closed the margin gap.
Bearing this out to some extent is a company by company comparison. Newmont, virtually unhedged, has suffered the same cost inflation of 33% per ounce produced as Barrick, which is heavily hedged. In the same period since September 2001, partially hedged Meridian and unhedged Goldcorp have seen costs creep up 17%, whilst world number two hedger AngloGold is just behind at 14%. Only Agnico has reduced costs (16%) and that was touch-and-go before it sorted out operational problems.
Lack of volatility in the margins of the Amigos is also notable. Their margins have marched in near lockstep with changes in the gold price except where the overwhelming weight of Goldcorp decisions has changed the balance. At least there has been volatility in revenue, cash flow and EBITDA although it has not leveraged the gold price as well as might have been expected.
One myth that has been firmly shattered is the prediction that hedged producers would fail at gold prices higher than $300/oz. The Top Guns actually consistently matched the weighted average realized gold price achieved by the Amigos through the cycle to $400/oz plus. It was only as Barrick changed tack on its hedging in late 2003 that the Top Guns proved unable to match the Amigos on an aggregated basis (See chart 4).
With gold prices holding above $400/oz recently it remains to be seen just how far Barrick is prepared to go to lighten its hedging load. We'll soon know from the third quarter returns, but it is unlikely to have been very aggressive and the situation is compounded by a ratings review on its debt.
Critics and cynics will note that whilst some gold producers found a way to be price makers of a sort in lean times, there has been no substitute in an era of stronger gold prices. None of the six producers in this review has found a way to consistently beat the spot market. Producers that are investing in value added products have yet to find a way to deliver most of their production into it.
Where the Amigos have outperformed by a country mile is cash accumulation (See chart 5). Both groups are guilty of tapping the market too often to pad treasuries rather than generating free cash from operations, but Meridian and Goldcorp stand out for the money their mines have minted.
The Top Guns have increased shares in issue by 54% since the first quarter of 2000, whereas the Amigos have diluted shareholders by just 19%. As if that difference is not large enough consider that the Amigos achieved a doubling of production per thousand shares outstanding - most of that achievement belongs to Goldcorp - whereas the Top Guns cut per-share production by 23%. Put another way, the net Top Gun dilution is 77% against an 84% accretion among the Amigos. (See chart 6)
That is the principal reason why stock prices between the two groups have diverged so much. Only Newmont has beaten the general trend.
When you look at what really counts, market capitalisation, the Amigos' advantage began to dissipate from the middle of 2002, not even a year into the new bull market. For most of the past year all six companies have traded in near parallel, which is far different from the breakout achieved by the Amigos by the end of the second quarter of 2001. Since then they have made heavy weather of it despite their putative advantage. (See chart 7)
The Top Guns have Newmont to thank for helping them out. If you were to exclude the number one gold producer then a difference is created of roughly 100% in the relative appreciation in market value since January 2000.
Newmont's performance signals that "formula" is only part of the equation. Marketing mojo, a lock on the S&P500, plus gold market "formula" has turned Newmont into the most impressive performer in this bull cycle.
It is by far the most liquid of the six stocks having traded nearly 60% of the combined total from January 2000 to mid-September; some 4.4 billion shares worth $135.5 billion. The next nearest is Barrick with 2.8 million shares traded worth $47.4 billion over the same period.
In relative terms Newmont is also king having traded shares worth 22.1 million times more than its weighted average market capitalisation. However, the other two Top Guns could not achieve better liquidity than the Amigos. Goldcorp ranks second with shares traded worth more than 14.6 million times its weighted average market capitalisation.