With the Fed beginning to dial down its quantitative easing programs and economy finally moving in somewhat of a positive direction, gold prices have been on a one way ticket downwards. The precious metal experienced a 23% decline over last quarter to fall to just below $1200 an ounce. That was the worst quarterly decline since 1975. Funds like the physically-backed SPDR Gold Shares (NYSE:GLD) now sit at new 52-week lows.
Perhaps fairing worse than the metal itself has been those firms that dig it out of the ground.
The gold miners have imploded over the last few months as the price of the yellow metal has sunk. However, while it may tempting to bottom fish, the worst could still be ahead for the sector.
Below The Cost Of Production
Gold bullion has fallen 10% since Fed Chairman Ben Bernanke last month said the economy was recovering strongly enough for the central bank to begin “tapering” its $85 billion monthly bond-buying stimulus this year. That hasn’t sat too well with the firms that mine precious metals nor their share prices.
SEE: What To Do About Gold Now
The industry benchmark fund- the Market Vectors Gold Miners ETF (NYSE:GDX) - is down nearly 50% year to date. Yet, there could be still more pain on the horizon.
That’s because the all-in cash cost for gold production is currently above what the precious metal is trading for. According to Citigroup (NYSE:C) a combination of rising costs- such as labor and energy inputs- sustained high CAPEX budgets, along with falling gold prices have resulted in a fast contraction in margins. Analysts now estimate that these factors will prevent any gold company in their coverage universe will generate free cash flow at current spot gold prices. This bearish forecast echoes similar predictions by analysts at Jeffries, in which that firm forecasts that the major miners are likely “to generate negative free cash flow over the next several years.”
Citigroup data shows that many of the largest mining firms are losing money with the yellow metal’s spot price below $1,300 an ounce. The all-in costs of production for companies such as Goldcorp (NYSE:GG), Barrick (NYSE:ABX), Newmont Mining (NYSE:NEM) and Yamana Gold (NYSE:AUY) are in the range of $1,400 to $1,600 an ounce.
In the face of lowered price targets for gold, the miner’s costs continue to rise. Both electricity and diesel fuel continue to skyrocket, while wages for labor are reaching new highs. The latest sector-wide pay demands are for hikes ranging from 60% to 150%. Meanwhile, miners continue to unearth lower grade ores. These lower grade ores mean the companies have to dig up more land in order to produce the same amount of gold. That adds to the already high costs of production.
Taking A Dour Approach
Given the potential headwinds facing the gold mining industry, a major shake-out could be brewing as several of the smaller and less-capitalized miners will have trouble keeping the lights on in this high cost/low bullion price world. If investors are tempted by the recent share price declines, then focusing on the larger miners like Barrick or Agnico Eagle (NYSE: AEM) may be warranted. However, with the conditions potentially lasting a few years or more, it might actually be more profitable to short shares of the mining firms.
The easiest way is through the Direxion Daily Gold Miners Bear 3X Shares (NASDAQ:DUST). The ETF uses future contracts and leverage to short the previously mentioned Market Vectors Gold Miners ETF. So far, DUST has surged and is up an astonishing 140% this past three months. While that is a huge gain, the fund could see more over the next few months as gold continues lower and costs rise at the miners.
SEE: Leveraged ETFs: Are They Right For You?
Suffering worse than the big boys have been the junior miners. These small-fries are less capitalized than the larger mining firms like Barrick are the least likely to survive a continued gold price rout. While there is no dedicated short ETF that tracks the sector, investors shouldn’t have to any trouble shorting the highly liquid Market Vectors Junior Gold Miners ETF (NASDAQ:GDXJ)- which bets on basket of these firms.
The Bottom Line
With gold’s recent price drop and lowered future price targets, the miners are in a world of hurt. Cash costs for the sector are now well above the breakeven point. With costs still rising, investors still have time to get short shares of the gold producers as the sector rout takes hold. The previous picks are great ways to do just that.