Gold Miners: Still a Good Short
Jake is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you have been following markets recently, you have undoubtedly seen the rout in gold prices with the yellow metal falling faster and farther than any other time in the last 30 years. Fears that gold is no longer a safe haven have fueled this decline, especially amid governments offloading portions of their gold reserves. This is particularly bad news for cautious investors who maintain the "5%-10% rule" so that rises in gold will offset potential losses in the equity portion of their portfolios.
The gold crash of 2013
We have seen a tremendous fall in the price of gold this year, which affects more than just commodity prices, as it's also bad news for gold miners, who calculate part of the value of their assets using gold prices. Gold miners have gotten crushed this past week because of lost assets and diminishing hopes for high revenues when selling their product. In particular, Barrick Gold (NYSE: ABX), the world's largest gold producer, has seen enormous price hits, falling from a high of $29.39 in April to a price of $16.11 as of June 24. Nearly 10% of the gold mined each year comes from Barrick, who extracted 7.4 million ounces of gold in 2012 alone. According to TREFIS, Gold makes up 91% of Barrick's stock price, and as the price of gold falls, Barrick has been forced to declare plans to lay off nearly 33%, or 6,600, of its employees to compensate for devastating losses in assets and future profits. This means that future gold production by the world's largest producer will be much lower than it has been, and if other miners follow suit this could cause a significant decrease in supply.
Another gold miner in a sinking ship is Freeport-McMoRan (NYSE: FCX). Freeport is the largest copper producer in the world, but gold still makes up 15% of its stock price, according to TREFIS. Freeport owns a 76.6% stake in the Grasberg mine in Indonesia, the largest gold mine in the world. On May 20 of this year, a collapse in the mine killed 28 miners and caused the Indonesian government to the close the mine for the next three months while an investigation occurs. Grasberg's closing has left more than 19,000 gold miners temporarily out of work, slowing the pace of global gold production. Shares of Freeport fell 3% the day of the collapse, and have continued fall another 16% since then.
Another serious competitor to these two miners is Newmont Mining (NYSE: NEM), the largest gold mining company in America and the third largest in the world. Newmont produces more than five million ounces of gold per year with a team of 34,000 employees. In an effort to cut losses due to the crash in gold prices, Newmont announced plans to lay off at least 33% of its workforce in Colorado over the next 90 days. Future operations for Newmont appear dismal, even to the company's executives, as insider trading reports, according to Nasdaq, show more than 20% of insider-held shares have been sold so far this year.
An uncomfortably small margin
Even worse, these companies may not even be profitable in the near future. Goldman Sachs stated that, in order for the gold mining industry to be profitable, the price per ounce for gold must remain above $1,200, a scary thought considering gold is now below $1,300 per ounce. With central banks holding roughly 16.5% of the world's gold supply, a continued sell-off would have detrimental effects on the price of gold, and the increase in supply from lessened reserves would certainly outweigh the decrease in the supply of gold from fewer opened mines and working miners. A short in any one of these companies could be highly profitable for the investor, especially if the price of gold does in fact end up falling below $1,200 per ounce.
As they stand now, gold miner stocks are positioned for a much larger price drop. If you buy shares of a gold miner that is releasing earnings soon, disappointing numbers for revenue and profit, based on a lower sales price for gold, could push stocks down even lower. Even more, if the price of gold ends up dipping below $1,200 per ounce, gold miners will get destroyed in the stock market as they are no longer profitable.
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Jake Pompeo has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!