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Barrick Gold Corporation (USA) (ABX), Newmont Mining Corp (NEM): Can Gold Miners Drop Even Further?

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Gold miners in general, which are represented in the Market Vectors Gold MinersETF, and the world’s biggest gold producer, Barrick Gold Corporation (USA) (NYSE:ABX), in particular are not looking so good following the drop in gold prices. While on one hand, the fall in the value of the precious metal has exposed the massive debt of these miners, on the other hand, Barrick Gold has to deal with its massive mine on the Chile-Argentina border which is now looking less lucrative.

Barrick Gold Corporation (USA) (NYSE:ABX)

Analysts have also pointed out that some of the leading gold miners are going to write down the value of their assets in the coming quarters. While some believe that the sector has hit rock bottom, I think that it can go down even further.

Gold miners, who had amassed enormous amounts of debt, are now cutting down their costs and selling assets to improve their cash position in order to avoid any possible downgrade to their credit rating. According to BMO Capital Markets, in the last decade, the net debt of 55 precious metal firms has increased more than ten folds from less than $2 billion to $21 billion.

Barrick Gold is at the top of this list. The company’s debt has ballooned from $6.6 billion at the end 2010 to $14 billion in December 2012. During this period, its debt-to-equity ratio, a primary solvency ratio which measures debt as a percentage of shareholders’ equity, deteriorated significantly from 34% in 2010 to 64% in 2012. Some of this rise can be attributed to the poorly timed debt-financed purchase of the copper miner EQUINOX MINERALS (OTCMKTS:EQNMF) for $7.65 billion, which was followed by a fall in copper prices.

Newmont Mining Corp (NYSE:NEM) is also not doing too well as its debt-to-equity ratio has risen from 33% in 2010 to 46% in 2012 while its total debt has gone up from $4.4 billion to $6.3 billion in the corresponding period.

With the drop in gold prices, Newmont’s stock has tanked and is now trading below its 2009 levels. As a result, the company now gives an attractive yield of more than 5% which could lure some of the yield hunters, but based on its debt levels pointed out above, its fundamentals have only gotten worse. In 2009, it was trading a little above its current price levels but carried $1.58 billion less debt than today.

Moreover, the company has a gold linked dividend policy, which means that the dividend is cut with the drop in prices of gold, which happened this year in April. With the weakness in gold prices, more dividend cuts would happen in the future. Yield hunters should note that with optimistic assumptions of future gold prices, Newmont Mining Corp (NYSE:NEM)’s yield could fall to just 2.8%. Therefore, I would not recommend Newmont, not even to those looking just for high yield.

If the ratings agencies lower the credit ratings of these gold miners, then that would make borrowing more expensive, which would add to the monumental challenges they are already facing. Standard & Poor’s has warned that with the current levels of expenditures, if the gold prices remain at or below $1,300 per troy ounce for more than six months, then we will most certainly see a downgrade. With their massive debt levels, I believe that Barrick Gold Corporation (USA) (NYSE:ABX) and Newmont Mining Corp (NYSE:NEM) face the biggest risk of a downgrade. However, radical divestment and cost cutting measures could save them.

To make matters worse, the cost of mining has been rising. According to BMO’s estimates, mining costs per ounce of gold have risen by as much as 177% in the last seven years.

Meanwhile, Barrick Gold’s flagship Chilean Pascua Lama gold mine project, whose operations were suspended in April due to environmental concerns, has given another bad news to its investors; Barrick Gold Corporation (USA) (NYSE:ABX) will now incur enormous post-tax charges of about $5 billion related to the mine due to delays and the drop in precious metal prices. This could turn out to be the biggest one-time charges ever incurred by any company in the gold mining sector.

The company has now reduced its 2013-14 capital expenditure on the project by $1.5 billion-$1.8 billion to $2.8 billion-$3.2 billion. It has submitted a new plan to the Chilean government and now aims to complete the project by the end of next year.

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