As the crisis in Syria appears headed toward a resolution, key commodities markets are no longer on edge. Oil prices have begun to slip, and gold prices have resumed their downward trajectory, making a quick retreat from their 150-day moving average.
Falling gold prices can spell serious trouble for gold miners. In recent years, mining costs have steadily increased due to higher labor costs, a greater regulatory burden and a move toward more deeply buried seams of gold. As an example, Barrick Gold Corporation (USA) (NYSE:ABX) has taken a $5.1 billion charge to reflect higher costs at its new Pascua-Lama mine.
Gold prices have been under pressure since this spring when analysts at Goldman Sachs Group, Inc. (NYSE:GS) suggested that there was no fundamental reason for gold prices to remain above $1,500, especially since inflationary fears have increasingly proved to be unfounded.
At the time, they predicted that gold would fall to $1,200 or $1,300 an ounce in the near term, and perhaps lower in the long term.
In a Sept. 16 note to clients, Goldman’s Jeffrey Currie provided an updated view: “We continue to expect that gold prices will resume their decline heading into 2014 when we expect economic data to solidly confirm a reacceleration in US growth and warrant a less accommodative monetary policy stance. Our end of 2014 price forecast therefore is unchanged at $1,050/oz, implying 20% downside potential from current prices.”
Currie also suggested another negative catalyst may knock gold prices down even more. “The recent pressure on [emerging market] economies and current accounts could accelerate the decline in gold prices as it forces such countries to slow their domestic gold demand, imports and reserve accumulation.”
The difference between $1,300 gold and $1,000 gold means the difference between profits and losses at many mines. This is painful enough for any gold miner that must buckle down and wait for the next cyclical upturn for gold. But Newmont Mining Corp (NYSE:NEM) doesn’t have the luxury of time.
In 2012, this gold miner spent $3.2 billion on mine development, which was roughly twice the company’s 10-year average. To pay for that, total debt swelled from $4.3 billion at the end of 2011 to $6.3 billion at the end of 2012.
Currently, NEM’s total debt is listed at $6.77 billion, and the company said it plans to spend more than $2 billion this year to complete mining development work that began a year or two ago. Analysts at Citigroup Inc. (NYSE:C) think the company will need to deploy a further $3.5 billion in capital spending spread over the next two years as well.
Meanwhile, the recent plunge in gold and copper prices led Newmont Mining Corp (NYSE:NEM) to write off more than $2 billion from its stated asset value when quarterly results were released in late July. If commodity prices fall further and stay down for several years, Newmont’s debt load may start to force the company to sell assets, likely at prices well below what it spent to acquire them. That’s the peril of a spending spree at the peak of a market.
At this juncture, you would expect Wall Street analysts to begin stress-testing the gold miners to see how they would fare in an environment of collapsing gold prices. Instead, a quick sampling of Wall Street research implies a head-in-the-sand approach.
For example, Merrill Lynch anticipates that Newmont Mining Corp (NYSE:NEM) will generate $400 million in free cash flow in 2014 and nearly $600 million in free cash flow by 2015. Yet those forecasts assume that gold prices will average $1,520 an ounce in 2014 and $1,570 in 2015. In other words, they are pretty worthless right now.
How do Newmont Mining Corp (NYSE:NEM)’s mining costs relate to gold prices? The recent asset write-downs and various charges have made the analysis a bit murky, but analysts at UBS AG (USA) (NYSE:UBS) have made a best guess: “All-in cash costs remain at $1,100-$1,200/oz excluding the write-downs but have been revised upwards to $1,200-$1,300/oz inclusive of these charges.”
Analysts at Citigroup Inc. (NYSE:C) have a slightly different take: “Excluding stockpile write downs, all-in sustaining cash cost guidance for the year remains unchanged at $1,100-$1,200/oz.” In other words, gold prices at $1,000 an ounce would be problematic for a company with such a high debt load.
UBS AG (USA) (NYSE:UBS)’ profit forecasts, which anticipate Newmont Mining Corp (NYSE:NEM) earning roughly $1.50 a share this year, were made when gold traded for $1,470 per ounce. Translation: Look for analysts to reduce their estimates when Q3 results roll around and perhaps sharply reduce them if gold slips below $1,200 an ounce.
Newmont’s high debt load, still considerable capital spending needs and soon-to-be falling profit forecasts put the company’s shares on a collision course.
In the near term, shares are vulnerable to downward profit forecast revisions when the company releases Q3 results, scheduled for Oct. 28, reflecting the reality of $1,300 gold.
In the intermediate term, if gold tumbles to $1,050 an ounce in 2014, as Goldman Sachs Group, Inc. (NYSE:GS) anticipates, then shares are poised for an even deeper slump. That makes NEM a stock to avoid at all costs for investors, and for short sellers, an increasingly appealing target.
Over the next year or two, if gold prices remain below $1,000 an ounce, then Newmont will likely need to pursue asset sales at distressed prices to address its debt obligations.
Recommended Trade Setup:
— Short NEM at prices down to $24
— Set stop-loss at $31
— Set initial price target at $20 for a potential 17% gain in four months
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