How profitable is gold mining

Should investors invest in gold mining stocks now?

Fear of the consequences of the global spread of the corona virus is causing strong fluctuations on the stock exchanges. The gold price, however, is rising to a seven-year high. Gold mining company stocks in particular could benefit now.

An analysis by Vontobel

The fear of the consequences of the global spread of the corona virus is causing strong fluctuations on the stock exchanges. The German Bundesbank recently issued a warning: "The growth losses could be noticeably higher than during the SARS epidemic of 2002/2003, when the number of infected people was significantly lower and the authorities reacted less rigorously." On February 24th An increase in coronavirus cases outside of China led to fears of a pandemic and brought price setbacks on stock exchanges around the world. The DAX suffered the biggest daily loss since the Brexit referendum in June 2016.
The rise in coronavirus cases in Italy, South Korea and Iran fueled further gold demand. As is currently the case, gold is viewed as an important investment option in times of financial uncertainty. According to reports by Manager Magazin, the gold price rose to a seven-year high of 1,688.66 US dollars per troy ounce on Monday afternoon (February 24, 2020) and was heading for the largest daily gain in three and a half years. In euros, the precious metal was more expensive than ever at 1,560.39 euros. That would have been the eighth day in a row with a record high.

Repositioning in the market with gold mining companies

Due to the negative correlation between the gold price and the share price, gold mining companies could benefit from the current stock market situation. The zero interest rate policy, coupled with geopolitical risks and the current spread of the coronavirus, are causing investors to fear recession. Gold mining stocks could thus be used to earn money in the current gold rush. Share certificates from gold mining companies have a so-called gold price lever. A rising gold price can, at least in the short term, have a disproportionate effect on the company's profit growth if the production costs remain fixed.

Extraction costs play an important role in the valuation of gold mines. The cheaper the precious metal can be mined, the higher the profit potential of the company. However, mining companies' gold reserves are finite. If the reserves are exhausted, the mines have to close. In order to secure gold reserves, exploration must begin early. Explorations are costly and productive mines can often only be found with considerable effort, and failure cannot be ruled out. If the investment costs incurred are added to the production costs, only a few gold mining companies can operate profitably. The fact that the gold price moved in a narrow range between $ 1,100.00 and $ 1,300.00 from 2013 to the beginning of the year and new reserves had to be secured resulted in a consolidation of the industry.

As a result of the consolidation, among others, Barrick Gold took over the mining company Randgold Resources. Barrick Gold already owned very rich mines with a high gold content, according to Börse Online, before the takeover. The better mining areas with up to four grams of gold per ton of rock, however, had Randgold. The merger would give Barrick Gold a gold grade of 1.7 grams per ton of rock. The US competitor Newmont Mining would come to around one gram per ton of rock. Newmont is the largest gold mining company in the world, with gold reserves of 100.2 million and an attributable production of 6.3 million troy ounces of gold. As such, Newmont is one of the few profitable companies in the industry. In 2019, Newmont generated $ 1.4 billion in free cash flow from its existing portfolio and ran four new projects on four continents (Tanami Power in Australia, Borden in Canada, Ahafo Mill Expansion in Africa, and Quecher Main in Peru) on schedule and within budget, said Tom Palmer, President and CEO of Newmont. Barrick Gold, the second largest mining company, has reserves of 71 million troy ounces. In 2019, Barrick's gold production hit 5.46 million troy ounces (at one of the lowest total cost in the industry of $ 894 per troy ounce), a new high with free cash flow of $ 1.13 billion.

The outlook

It is currently expected that the major central banks will pursue a loose monetary policy in order to add more liquidity to the system. Lower interest rates lower the opportunity cost of holding non-profitable gold bars and make gold cheaper for investors holding other currencies. Buying pressure on gold could continue if investors focus on precious metals as a store of wealth and to hedge against market turmoil. In addition, central banks could buy gold for quick balance sheet expansion, which would cause the price of gold to rise.

The Chinese state and party leader Xi Jinping said last Sunday (February 23, 2020) that the coronavirus will have a significant impact on the economy and society. The background is extensive restrictions on the movement of people and goods to contain the virus. According to a report in the Handelszeitung, experts expect further economic support from the government and the central bank. This harbors long-term risks from increased debt. A devaluation of the Chinese yuan could further fuel demand for gold, which is seen as a crisis currency.

Also read: Lufthansa share: That's how big the bargain opportunity is

05.03.2020 | 17:25