Gold sector outlook – Ramelius and Regis Resources could be cheap

Financial journalist
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When gold hit the skids in that alarming 48-hour period last week – in which the yellow metal plunged 13% in two days – alarm would have shot through more than one gold miner’s boardroom.

That sickening near-$200 fall (from US$1,560 to US$1,360) last week would have brought a queasy feeling to the producers at the top end of the Australian production cost curve, which independent analyst Peter Strachan, of StockAnalysis, reckons runs from about US$500 an ounce to as high as $1300 an ounce, with an average of somewhere around $800–$850 an ounce (at times when the A$/US$ exchange rate diverges from parity, investors would use the A$ cost of production, because that is the currency in which the producers report).

High costs

Certainly gold’s mid-April tumble was not a good experience for the producers considered high-cost, which include the likes of Evolution Mining, Ramelius Resources, Reed Resources, Norton Gold Fields, Focus Minerals and Saracen Mineral Holdings.

A recent Bell Potter survey of 15 mid-tier Australian producers showed that total production costs averaged A$1,170 an ounce. The broker said five of those 15 would be “marginal” at current prices.

For its part, JPMorgan reckons the Australian-listed gold miners it covers have “all-in” production costs (all costs related to running existing operations) of between A$1,050–$1,130 an ounce. That does not leave much margin.

The thing about gold margins is that miners alter what they do in response to the gold price – which makes looking at production costs on their own simplistic.

Other levers

As cost inflation (the current bugbear of Australian mining) and the prevailing gold price fluctuate, the other side is that miners adjust the grade (proportion of gold per tonne of ore) they mine.

Over the past decade, as gold prices have risen, producers have deliberately lowered their gold ore grades, says Dr. Sandra Close, director of gold consulting company Surbiton. They used stockpiles of lower-grade ore – which had become more economic to produce – to blend in with the run-of-mine ore, which increased their cash costs of production and reduced the amount of gold they produced each period. In this way, operations remain profitable while optimising the life of the mine and extracting as much gold from the deposit as possible.

If gold prices remain low, she says, the process can be reversed – resulting in more higher-grade ore being processed, increasing gold grades and reducing cash costs.

Margin play

Companies will be doing everything they can to improve their margins – or reassure the market that their margins are fine, as St. Barbara Limited (which mines gold in Western Australia, Papua New Guinea and the Solomon Islands) did in a statement this week. St. Barbara said: “Each of the company’s gold operations have been reassessed in response to the recent and significant decline in the gold price, and all are expected to achieve satisfactory returns at current gold prices (around US$1400 per ounce).” Expect to see more of that kind of thing.

The other factor that is back in the market is hedging, which fell out of favour over the long period of rising prices. Companies were reluctant to hedge while prices were rising, because it removed the upside. In the wake of April’s price slump, suddenly the market is keener to talk about hedging. For example, Evolution Mining has told the market it is partially sheltered from the recent sharp drop in gold prices, due to roughly 150,000 ounces hedged at A$1573 an ounce. That is more than sufficient for the company to see out the rest of this financial year.

These are the kinds of company-specific factors that investors will be focusing on, not just the “exposure” they’re getting to gold.

Prospects

These company-specific factors can work in your favour: if your fund is in accumulation phase, you can use the leverage some smaller gold producers (and project developers) have to a recovering gold price.

For example, Ord Minnett says the best high margin/low-cost gold candidates are ABM Resources (ABU), which is developing the high-grade Old Pirate deposit in the Northern Territory; Beadell Resources (BDR), which operates the Tucano mine in northern Brazil; and Medusa Mining (MML), which began producing at its high-grade, low-cost Co O mine in the Philippines this year.

The broker also has buys on Western Australian producer trio Saracen Mineral Holdings (SAR), Ramelius Resources (RMS) and Northern Star Resources (NST); Sumatra Copper & Gold (SUM), which is developing its Tembang project in Indonesia; as well as St Barbara (SBM).

Local (WA and NSW) miner Regis Resources (RRL) could also be worth a look, as a low-cost ($515 an ounce last half-year) – but low-grade – operator that has flagged a dividend payment this financial year; as could Perth-based Troy Resources (TRY), which owns producing mines in Brazil and Argentina, and is taking over Guyana-based explorer Azimuth, which has some high-potential properties in that country.

If you think gold will rise, some of these stocks could be worth a small allocation. For added comfort, Medusa Mining and Northern Star Resources pay dividends, while Ramelius Resources expects to pay a maiden dividend next financial year.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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