Are Dark Days Still Ahead for These Miners?

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

It's no secret that the basic materials sector has seen some rough times lately. However, a bullish spike last year offered hope. Investors cheered the Chinese stimulus package and thought it might contribute to support levels in key commodities. Steel temporarily spiked and copper seemed like it was on the radar for the first time in years. Fast forward 12 months to the present and it's painfully clear now support for higher prices never materialized.

What's even more painful is the future of companies that deal in copper, steel, gold, silver, and coal, just to name a few. Macroeconomic fundamentals continue to point down for these commodities due to lackluster demand, oversupply, and rising operating costs. Investors have come to the realization that there is no silver bullet and trickle down government intervention doesn't create the real demand needed for growth or even profitability in this industry.

Freeport Gets Hurt

One of the largest mining companies is Freeport-McMoran (NYSE: FCX) which mines both copper and gold. Copper is often thought of as a proxy for real economic growth. Gold is seen as an inflation hedge or fear barometer depending on whom you ask. Both are subject to market swings depending on the global economic cycle. It's not often both trade in tandem, but when they do it can mean either good times or disaster for companies like Freeport.

Since both gold and copper are openly traded in commodity markets the prices companies are set to receive per quarter and year can be forecast well in advance. This makes stocks of this nature some of the easiest to predict provided operating costs do not surprise.

In the first quarter (Q1) of  2012 the average price realized per pound of copper was $3.82. Compare that to the most recent quarter, Q1 of 2013, where the average price was $3.51. That's about an 8% drop. Things are not looking any better with copper currently trading at $3.22/pound. Copper makes up over 80% of Freeport's sales. Analysts don't seem to be seeing any reason for the decline to stop with the most recent data out of China showing very tame demand.

Gold didn't do much better for Freeport, decreasing from $1,694/ounce in Q1 of 2012 to $1,606/ounce in Q1 of 2013. Currently gold is trading at $1,386/ounce and appears to be on a solid downtrend. Since gold makes up almost 18% of total sales revenue this drastically reduced price will force the company to revise their $1,400/per ounce sales forecast for 2013.

With these trends firmly in place it easy to see why Freeport has declined almost 50% from the beginning of 2011. It's also easy to understand why this downtrend will continue and why I cannot recommend an investment in this stock.

Fool's Gold

Knowing that the prices for gold are in decline and will most likely continue to decline can also lead us to make some major conclusions about other players in the gold sector.

Barrick Gold (NYSE: ABX) is a leading gold producer that has seen a dramatic decline in stock price of 60% since the beginning of 2011.

In Q1 2012 Barrick was commanding a whopping $1,691/ounce of gold. As noted above the current price is $1,386 -- an almost 20% drop. Look for Q2 2013 quarterly results to begin reflecting this. Over this same time operating costs have climbed, future investment has been curtailed, and production has dropped.

But gold isn't the only major mineral play that Barrick Gold has in its portfolio. It also mines copper. Oh, shucks. This is sounding familiar. I read somewhere recently that copper is also declining. I think it was that brilliant author from The Motley Fool.

Other players in the gold mining sector should see continued pressure based on the decreasing realized price. IAMGOLD (NYSE: IAG) with their declining productivity and astronomically high extraction costs per ounce should be avoided.

Recently in their Q1 2013 report they showed a drop of 9% in gold production "due to the impact of lower grades and the increase in processing hard rock together with inflationary cost pressures across all sites." As a result extraction costs jumped 16% year-over-year to $787/ounce. Compare that to Barrick Gold's $561/ounce extraction cost during that same period.

While IAMGOLD touts exploration projects the recent quarterly report is ripe with desperate cost cutting measures such as hiring freezes, curtailing executive privileges, and discussions with suppliers to reduce costs.

With gold trading lower and costs to extract that gold rising, look for things to get much worse for IAMGOLD before they get any better.

Conclusion

Some of the most predictable stocks are those with transparent pricing. Investors can keep track of their investments by looking at the prices received for commodities those companies exploit. When macroeconomic fundamentals suggest a continuing path and the market seems to agree it is futile to fight the trend.


James Catlin 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!

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