Scary Days Down the Gold Mine

John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Two years ago, before I became a Fool blogger, I was a blogger for a libertarian movie company called Silver Circle. My job then was to write articles and share stories regarding the Federal Reserve and how it was damaging the dollar. To emphasize these points, I would typically point to the sky-high price of gold and how its strength reflected the growing weakness in the dollar, as well as showing the world why gold is such a great symbol of wealth.

And now, having moved on from that job, I am here to write about the remarkable downturn that gold has taken, and how a charging bull commodity became a big, wooly bear, something that in 2011 appeared almost unthinkable.

Diving gold

In the last year, gold has fallen by 23.2% compared to the dollar, a drop of $370 to $1,227/oz as of June 26, a three-year low. This is largely due to rumors of the US Federal Reserve decreasing its stimulus operations, which in turn would strengthen the US dollar, the base currency that gold trades in, meaning that billions in metal investments have been wiped out. In some cases, hedge funds have even shed gold investment due to the price drop.

Labor unrest in South Africa hurting gold companies

It should therefore come as no surprise that the biggest losers of the past year have been gold mining stocks like Barrick Gold (NYSE: ABX) and AngloGold Ashanti (ADR) (NYSE: AU), which run two of South Africa’s biggest gold mines. Barrick’s share price has plunged 47.4% over the past year, with AngloGold falling 59.4%. This is in relation to the gold output costs being as high as $896/oz. This leaves little room for profitability for either company in South Africa, one of the biggest gold mining regions in the world.

To make matters worse, South African miners’ unions have threatened labor strikes and mine closures unless they get better base pay and improved worker conditions. For these two companies, this is a request too far because under current labor contracts, miners get paid at rates that make it nearly unprofitable already given the low price of gold.

According to some company analysts, gold has to be $1,400/oz on the commodity market for increases in pay to be affordable, the so-called “red line”. With gold nearly $200 below that, it is incredibly difficult, putting mining companies in a bind over taking an indefinite loss of profitability or risking a mine closure.

For AngloGold, which runs the deep Mponeng mine, this would be consequential for world gold markets as well as for the company's continued business in the country. Barrick would then be poised to reap the benefits as the second-biggest player in the country, despite higher costs. Either way, both companies would have to hope that the labor unrest is controlled, or if gold prices rebound.

Mexican farmers vs. Goldcorp

Meanwhile in Mexico, the biggest gold producer in terms of market value, Goldcorp (NYSE: GG), has just come out of negotiations with farmers over rented land for the Penasquito mine. The farmers demanded a yearly payment of nearly $3 million/year for the land rather than the previously agreed upon $224,000 lease that Goldcorp signed on to. The farmers’ claim was that the land was being rented for far less than those in neighboring towns were getting, while Goldcorp claimed it was a fair price and was unwilling to up the price.

Like the two companies in South Africa, Goldcorp’s unwillingness to compromise may have a lot to do with the poor fortunes of this company. Shares for Goldcorp fell 37.5% since this time last year, and unlike South Africa, Penasquito only has about 400,000 ounces of gold down below. That means Goldcorp has to rely on silver, tin, and copper deposits to boost its Mexican income during this bearish stretch that many in the industry hope is just temporary.

Price boom in the offering? Ask the feds

Thankfully though, it very well just might be. The Federal Reserve has made efforts to convince the investing world that it will continue its stimulus efforts into 2014, due to a still-slow US economy. Stronger economic data typically means a scaling back on stimulus spending, but to many Fed bankers, this hasn’t arrived yet. This news has contributed to a two-day rally in international stock markets after an incredibly volatile last couple of weeks. News of stimulus spending should mean that gold prices will be on the rise soon, but like other industries, it will come down to 10-year bond-yield figures as well as any news from Fed chairman Ben Bernanke.

Who glitters?

If gold does get back on its feet pricewise, these three companies will rise with it, a welcome sign for gold mining investors. AngloGold’s holding of the Mponeng mine gives it the inside track in South Africa due to lower output costs than rival Barrick, as well as a cheap P/E of 5.1. It has a significant advantage in terms of profit margin as well with nearly an 8.0% margin compared to the -6.0% margin of Barrick.

Analysts give this company a hold rating for the most part, though that represents a downgrade for AngloGold, but it should improve if continuing stimulus is going to be the law of the land. Also, a 1.4% dividend yield is something that seems pretty solid given the volatility of the market.

Goldcorp is always pretty solid, and is without a doubt the strongest of the three companies with profit margins at 30.1% and an E/P ratio of 7.9% growth. Dividend yields are the strongest as well at 2.4%, and a fairly solid 7.0% return on equity. However, its forward P/E at 11.5 is twice that of AngloGold, so it isn’t as affordable a pickup, but it does have a strong foundation and is a safe investment regardless.

If gold glitters again, AngloGold and Goldcorp could ride the tide, but in an increasingly volatile market, the horizon is far off.

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