Gold Miners' Shares Are Too Expensive To Own, And That's Going To Be A Big Problem For Producers: Citi

This story was updated at 8am on August 14, 2013.

Major gold producers must adapt to survive an ongoing decline in gold prices in the next several years, according to an in-depth Citigroup Inc. (NYSE:C) gold industry report from Tuesday.

As part of its sobering report, Citi analysts wrote: “The April price moves severely damaged the notion that gold provides any degree of risk protection or really acts as a safe haven. ... The opportunity cost of holding gold has never looked higher, when relative performance to other asset classes is assessed. Indeed, investor confidence in the recovery story, principally in the US, has clearly been at the expense of gold.”

The report fires a little barb at gold companies, noting that 10 top gold companies have collectively burnt through $11 billion in cash since 2000, despite a fourfold increase in gold prices. “Shareholders funded this, with the number of shares trebling during this period,” reads the note.

Citi analysts expect the trend of heavy spending funded by shareholders to continue and even accelerate as gold prices are low.

They noted that investors were sometimes led on by corporate promises that higher capital spending ultimately leads to greater and cheaper gold production. But these attractive promises “seldom materialized,” said the analysts.

“Gold companies failed to pass on benefits from the past four years’ heyday to shareholders. Now, they are finding themselves in a struggle to make ends meet,” wrote the analysts.

Barrick Gold Corporation (NYSE:ABX), the world’s largest gold producer by volume, reported steep profit declines of 22 percent in their latest quarterly earnings, after expensive one-time regulatory expenses related to their Chilean Pascua-Lama mine.

The world’s second-largest gold producer, Newmont Mining Corp (NYSE:NEM), said in its quarterly earnings late last month that lower gold and copper prices partly caused a $2 billion net loss to its shareholders.

The company also said it had cut spending by 10 percent compared to the first half of 2012, with capital spending in 2013 expected to be $200 million lower than previous targets.

AngloGold Ashanti Limited (ADR) (NYSE:AU), the world’s third largest producer, also cut capital spending for 2013 by $100 million, and posted a net loss of $135 million for the quarter.

In coming years, gold companies will sell off assets, close mines, and spend less on major capital projects and exploration, wrote the Citi analysts. But even these cutbacks arguably won’t be enough, they continued, in their pessimistic assessment of the gold mining industry.

Global gold capital spending by these companies has risen tenfold since 2000, but gold production actually fell 5 percent over the same period, according to a Citi analysis. And the cost to produce gold has also risen at an annual average of 16 percent since 2000.

That means gold companies are forced to spend more and more just to stay afloat with targets for production volume and expenses.

“A slow-down in capex will invariably result in a fall in production, which in turn will lead to a faster rise in unit costs,” wrote the analysts. “Whether they cut capex or not, we see both scenarios as bad for shareholders. There seems to be no easy way out.”

A spokesman for Barrick Gold didn't respond to a request for comment.

A spokesman for African Barrick Gold PLC (LON:ABG), one company Citi pegs as facing serious obstacles in coming years, declined to comment. Citi analysts described the company as a “shrinking producer” that may have to close down its unprofitable Tanzanian Buzwagi mine in the near future.

In a July press release, though, company CEO Greg Hawkins said production has beat internal targets. He also notes an ongoing formal review which seeks to cust costs at the company.

As for Ashanti, another company Citi expected to face tough times ahead, Stewart Bailey, Ashanti’s vice president for investor relations, told IBTimes in an email: “We do not comment on market speculation regarding our strategy to dispose of assets, or not, as the case may be.”

Citi analysts wrote that Ashanti is “particularly badly positioned” going forward, citing its failure to sell off costly assets in the past three years. They said that the company needs to sell or close 10 of its unprofitable or troubled mines.

Bailey pointed out that in recent years the company has already sold “a significant number of mines” in South Africa and elsewhere.

Bailey also said that corporate, administrative, and exploration savings of $460 million are expected for next year, alongside operating expense cuts of $500 million. That will improve overall production costs per ounce at Ashanti, he said.

Still, the Citi analysts noted that demand for physical gold, especially in Asia, outperformed the mediocre showing from miners' stocks.

Demand in India and China is expected to stay strong this year, industry group the World Gold Council has maintained.

Edmund Moy, a gold expert and former U.S. Mint director now with Morgan Gold, also told International Business Times that gold producers will likely face a tough time in coming years, if gold prices don’t rebound to $1,400/oz or more.

“They’ve also let some of their administrative costs kind of balloon out,” he told IBTimes. “There’s going to be room for them to cut, but not enough room to cut, to where, if gold stays at $1,330/oz, that it’s going to be profitable for them.”

Moy said that reduced gold mining capacity could also lead to tightened gold supplies in the near future. Moy said a rough rule of thumb among industry analysts is that production costs can average, industry-wide, at about $1,200/oz. “Unless people’s production costs are $800/oz, which I don’t think they are, a lot of these gold companies are going to cut back on their operations,” said Moy.

Citi forecasts that gold prices will average $1,185/oz in the second half of 2013, and $1,143/oz for 2014. Gold prices opened at $1,336/oz on Tuesday morning.

Not all analysts are pessimistic about gold prices and gold companies, of course.

Kimberly DuBord, a director of research at Briefing.com, is bullish on gold, insofar as it’s a store of value, whether it’s held by central banks, exchange traded funds, or private investors.

Barclays PLC (LON:BARC) analysts also wrote on Tuesday that gold prices have rebounded nearly 8.5 percent since the start of the third quarter, in July, or 12 percent from the 34-month low of June 28, according to Bloomberg Businessweek.