A Tale of Two Gold Miners: Kinross vs. Barrick
Pretty much every major gold mining company suffered as a result of falling gold prices. Not only did the market price of gold fall by some 30 percent – 40 percent, but the cost of mining gold generally rose during the bear market. So while in 2011 you had companies producing gold at $900/ounce and selling it at $1,700/ounce, in 2013 we had companies producing gold at $1,100/ounce and selling it at $1,300/ounce. This meant that profitability fell by 75 percent.
While some of the rising production costs were a result of inflation, a lot of it was a consequence of gold miners’ belief that the higher gold price was here to stay. Mining company executives wanted to produce more gold so that they could report production growth, and this meant that a lot of them decided to make acquisitions, or to start mining projects that were only economical in the higher gold price environment.
When the gold price fell, we started to see a new policy touted by executives — they now wanted to emphasize “quality of ounces” rather than “quantity of ounces,” meaning that they would focus on mining gold that was less costly to produce. They also wanted to strengthen their balance sheets, and this entailed paying off debt, slashing dividends, and issuing stock. As painful as this was, it needed to be done.
But while most large mining companies adopted this policy, some miners were more aggressive in pursuing it than others. With the prices of gold and mining shares down, I think this is an excellent opportunity to begin taking a long term position, and I think one criterion that investors should apply is the extent to which a company’s management reacted to lower prices. While it is simpler to just buy shares in the Market Vectors Gold Miner ETF (NYSEARCA:GDX), I think by applying these relatively simple screens, investors can markedly improve their long-term performance, as not only will they be choosing companies that have a stronger financial position, but they will be betting on managements that value a stong financial position.