In February of this year—after being bearish on gold prices during 2013 and 2014—I wrote an article discussing three reasons why I believe gold prices will bottom this year, and why I believe gold is a good investment at a level of around $1,200 an ounce, which is close to today’s price.
Since then, I have become even more convinced that gold prices will bottom this year.
Here are three reasons for my bullishness back in February:
- I expect gold mining production growth to disappoint on the low side as lower gold prices were beginning to force the majority of global gold miners to focus on cost-cutting instead of expanding existing or constructing new mines. I also stated that if gold prices decline to and stays below $1,200 an ounce, gold mining production growth will stop altogether. I.e. lower mine supply will eventually lead to higher gold prices;
- Global central banks, including the Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of England, and the People’s Bank of China, are still on an easing cycle; I also did not believe the Fed will hike interest rates anytime soon, and that most central banks, including the Fed, are still biased towards currency devaluation in the long-run;
- Chinese and Indian gold demand, which collectively make up more than 50% of world’s annual gold consumption, will continue to rise as the newly-minted middle class and rising incomes in both countries create higher demand for gold jewelry.
Firstly, global gold miners have continued to cut their capital expenditure budgets. Since the end of 2012, global gold miners have collectively slashed their capital expenditure budgets by about 50% in an effort to cut costs and prop up their profit margins. The decrease in capital expenditure spending is finally impacting supply on the downside. According to the World Gold Council, global mine production only grew by 2% year-over-year during the 1st quarter of 2015; more importantly, global mine production is expected to decline during the second half of this year, after growing by 4.7% a year from 2008 to 2013.
Secondly, I expect the Fed to continue to postpone its first interest rate hike, a theme which I have been reiterating since March. The fed funds futures market still does not expect the Fed to hike until its December 15-16, 2015 meeting. With U.S. industrial production capacity having peaked last November at 79.8% (vs. its preliminary April 2015 reading of 78.2%--its lowest reading since January 2014)—and with U.S. CPI inflation still relatively benign (the core CPI and median CPI readings for April 2015 were 1.8% and 2.2%, respectively), I would not be surprised if the Fed postpones its first interest rate hike until January next year.
Finally, with both the People’s Bank of China and the Reserve Bank of India still in easing mode, I believe Chinese and Indian consumer demand for gold jewelry will continue to rise for the foreseeable future. In my last article on gold, I mentioned that gold remains a solid, long-term investment and that any purchases could be made either through an ETF, e.g. the SPDR Gold Trust (GLD) or physical gold. However, since many global gold miners have seen their stocks sell off in the past year (GDX, the Market Vectors Gold Miners ETF, is down nearly 17% in the past year), certain gold mining stocks now offer a combination of compelling growth and value. Here are three gold mining stocks to consider:
1. Goldcorp Inc. (GG), with a market capitalization of $14.5 billion
GG’s all-in sustaining cost of production (or AISC, i.e. the cost of producing an ounce of gold plus the capital expenditures needed to sustain its production) during the 1st quarter of 2015 was $885 an ounce, putting GG as one of the lowest-cost producers in the industry. Moreover, GG’s AISC is projected to decrease further as its two recent development projects at Cerro Negro and Eleonore have extremely low-cost profiles. Combined, the commercialization of these two projects should help GG’s gold production increase from 2.9 million ounces last year to as much as 3.5 million ounces this year; at the same time, I expect GG’s AISC to decrease to as low as $750 an ounce next year. I expect GG’s free cash flow to surpass $1 billion next year even if gold prices stay at $1,200 an ounce, or equivalent to a highly-attractive 7% free cash flow yield in 2016.
2. Yamana Gold Inc. (AUY), with a market capitalization of $3.4 billion
AUY’s AISC during the 1st quarter of 2015 was $893 an ounce, which also puts AUY as one of the lowest-cost producers in the industry. AUY’s AISC is projected to remain flat even as the company is expected to grow its gold production from 1.2 million ounces in 2014 to 1.6 million ounces by 2018, due to the commercialization and expansion of two of its mines in Argentina. I expect AUY’s free cash flow to rise to nearly $300 million next year as it reduces its capital spending while ramping up production, putting the company’s 2016 free cash flow yield at nearly 9%.
3. Eldorado Gold (EGO), with a market capitalization of $3.4 billion
EGO’s AISC during the 1st quarter of 2015 was $729 an ounce, among the lowest in the industry, although the company maintained its 2015 full-year AISC guidance of $960 to $995 an ounce. EGO was the first North American gold miner to explore and commercialize a mine in China, and has significant experience in operating in countries with high political risk such as Turkey, Greece, and Romania. EGO’s gold production is expected to increase from 800,000 ounces in 2014 to nearly one million ounces in 2018. It is difficult to project EGO's free cash flow for this year or next year, as some of its new projects will not begin their operations until 2017. That said, EGO has a strong growth profile along with some of the lowest costs in the industry; as such, I expect the firm to do well even if gold prices remain depressed for the foreseeable future.
Disclosures: My firm, CB Capital Partners, or I may have material financial interests in GLD, GDX, GG, AUY, or EGO and may hold, sell, or trade them depending on market conditions or when fundamentals change.
