The headline from the Financial Times on July 20 read, “Gold Bugs Squashed by Aggressive Selling.”
And that was no exaggeration.
Gold just notched its longest losing streak since 1996. The price dropped for 10 consecutive days. It hit $1,088 per ounce, a level not seen since March 2010. Gold is now down 40% from its 2011 peak.
Why Gold Fell
As to why gold fell so much, the usual reasons were brought out. These included the strength of the U.S. dollar and the fear that the Federal Reserve would raise interest rates later this year.
Other short-term factors stemmed from China. First, its central bank revealed its gold holdings. It purchased 600 tons of gold from 2009 to the present. That figure was two to three times below what most gold market participants had anticipated.
Also, there was the Chinese stock market crash. Some players on margin may have had to liquidate other positions to cover margin calls.
Finally, there were rumors of Chinese hedge fund activities targeting gold, as $1.7 billion worth of gold was sold within a few minutes. Chinese hedge funds had already been pinpointed as the culprits behind a bear raid on copper earlier this year.
Finally, overall short interest in gold is nearing its peak, hit in 1995.
Gold Stocks Plunge
This latest drop in the price of gold is not good news for gold mining companies. For many miners, their break-even cost is around $1,100 an ounce. So any drop below that price will bring severe pain.
The selloff in gold stocks was led by the world’s top producer of gold, Barrick Gold (NYSE: ABX). It tumbled to the lowest level seen since 1990, and is down about 40% in just the past three months alone.
Barrick’s market capitalization of $8.5 billion is a mere shadow of its $64 billion market cap when gold was at its peak of $1,911 an ounce in August 2011.
Other gold mining stocks have also tumbled, including the likes of Newmont Mining (NYSE: NEM), Goldcorp (NYSE: GG), AngloGold Ashanti (NYSE: AU) and Agnico Eagle Mines (NYSE: AEM).
Dragged Down by Debt
It’s not just the falling gold price hitting the miners. Many are being dragged down by their heavy debt burdens.
Debt was used to expand gold volume outputs (no matter if it was profitable) when gold was flying high. Many managements got caught up in the moment and thought the good times would continue for many years.
Now they’re stuck with heavy debt and little ability to sell stock to raise capital to pay off debt.
Barrick, for example, has $10.6 billion in debt. That’s more than its market cap! The company had pledged to pay off $3 billion this year. But cash flow is now in question. Asset sales into a lousy market are now the best option.
Gold Mining Future
What does this all mean for the future of the gold mining industry?
Most gold mining companies have already done deep cost cutting. There is probably little more there left to squeeze out. The next stage for many companies will be the selling of assets and the abandonment of much of their exploration activities.
This is what happened in the 1990s. It eventually led to much lower gold production and the bull market for gold, which lasted over a decade. A replay is very much possible. That means long-term investors may want to position themselves for such an outcome.
To me, that means looking for a gold mining stock with good growth prospects and little debt. Such a company exists. It is Randgold Resources Ltd. (NASDAQ: GOLD).
Randgold’s gold output is less than a fifth of Barrick’s. Yet this Africa-focused miner’s market capitalization of $5.6 billion is about 60% of Barrick’s. The reason? Randgold has no debt.
Randgold is a growth company, too. It has been developing gold assets in western and central Africa, where it has been in operation for over 20 years.
Last year, Randgold raised its gold output by 26% to 1.1 million ounces. This year it has targeted production of 1.2 million ounces. Its total cash cost per ounce continues to drop, and right now is around $700 an ounce.
And with no debt and cash on its books, Randgold may be able to pick up gold assets dirt cheap from miners drowning in debt and forced to sell to stay alive.
Despite being taken down in price with the other gold stocks, Randgold looks to be a safer bet than the others. For investors looking to buy low on gold, gradually building a position in Randgold is the way to go.
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