… I’m hot on the trail of my first mining share recommendations in years. But mark my words: You simply can’t run out and buy any mining share or any group of miners these days.
Some will thrive, but many of today’s mining companies are on a path to self-destruction, even as gold and silver prices get ready to soar again.
There are a lot of reasons why. Chief among them are bad management, too much debt, production costs too high, the threat of rising interest rates and, amazingly, many miners think gold and silver are back in a bear market so they are starting to hedge their production and reserves and resources by selling forward again.
|Some mining stocks will thrive, but choosing which ones will be the big challenge.|
Imagine that. Say you’re a mining company with a modest 3 million ounces of gold reserves, or mineable gold. When gold hit its record high at $1,920 in September 2011, that gold was worth $5.76 billion.
Today it’s worth $3.22 billion. The gold has lost $2.54 billion of market value, or 44.1%.
It’s fallen so much that the price of gold is now near your total cost of production, at say $1,000 an ounce. You have virtually no gross profit margin left.
So you’re worried gold may fall further, below the cost of production. If that happens, it will certainly put you out of business.
Your inclination then is to hedge the value of your gold, so that if gold prices fall further, you’ve locked in its current price and you’re ok, or so you think.
And instead of cutting costs, making your mine more efficient, you go ahead and hedge your gold, selling 30,000 futures contracts of 100 ounces of gold per contract against your 3 million ounces.
But then, instead of falling further, gold explodes higher. Guess what happens next?
Instead of making money on your gold production, instead of seeing your resource values go up and your profit margin go up on the ounces produced …
You’ve locked in a tiny profit margin — BUT you start to get margin calls on your 30,000 futures contracts that you sold short as a hedge. A margin call will eat into your cash, a precious asset to a miner, since it’s such a cash and capital intensive business.
|“A margin call will eat into your cash, a precious asset to a miner.”|
Yet the price of gold continues higher and you have to keep funding the margin calls. It doesn’t take long.
You’re now pouring so much cash into your hedges, you’re having trouble making day-to-day expenses, like payroll, rent, equipment maintenance, employee health insurance, debt payments and more.
So what do you do next? You don’t want to be exposed to the vagaries of the swings in the gold market, so you keep your hedges in place.
But you need capital, so you go borrow more from your bank, or, you talk to your investment banker and you offer more shares to the public to raise capital.
Fine, you get your capital. But if it’s debt, you now have more debt on your balance sheet, which is just going to cost you more and more as interest rates rise.
And if you opted for equity instead, the new share offering simply dilutes down the value of your existing equity and shareholders, and that has its price too.
Bottom line: You essentially turned your business into one that’s supposed to profit from a rising gold price …
… Into one that doesn’t profit at all, and instead, barely survives — but only if the price of gold is falling!
So you see, it’s not all that easy to run out and buy mining shares these days. As beaten up as they are — with many having lost more than 90% of their value — in the last four years …
Many will get beaten up even more as gold and silver move back into renewed bull markets.
Stay safe and best wishes,
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No war: Turkey and Russia promised not to go to war over the downing of a Russian fighter jet. Still, Turkey’s NATO allies and others were wondering why, when minor violations of airspace are relatively common and usually tolerated, the Turks decided to risk a serious confrontation with Moscow by taking military action. Here’s a link to a New York Times story on the issue.
Attack thwarted? French authorities say another attack could have been hours away when police closed in on the suspects’ hideaway outside of Paris last week. Suspected ringleader Abdelhamid Abaaoud and another man were planning a suicide attack on the Paris financial district of La Defense on Nov. 18 or 19, the Paris prosecutor said Tuesday. Both men were killed during a raid in Saint-Denis before the attack could be carried out.
Mostly calm: Large but mostly peaceful protesters took to the streets overnight after the release of video that showed the fatal shooting of a black teenager by a white Chicago police officer. The protests came after the officer, Jason Van Dyke, was charged with first-degree murder in the shooting of Laquan McDonald, 17. The dashboard camera video shows the young man running and walking past officers in the middle of the street, then spinning and falling to the ground when bullets suddenly strike him. He moves briefly while on the ground but then is still after he appears to be shot several more times.
Whoops: On-line retailer Amazon.com sent out an unknown number of emails warning customers that the passwords on their accounts may have been “improperly stored (on customer devices) or transmitted to Amazon in a way that could potentially expose it to a third party.” Customer emails were then reset by Amazon, which led affected users to a page on the site where they could change the password to one of their choice.
Best wishes for a safe and enjoyable Thanksgiving,
The Money and Markets team