Stress Testing Gold Miners / Sector Review As Gold Plunges :$1,100 Gold Is Critical

from Morgan Stanley

While the analysts expect gold will probably end up around $1,050, they do say an interest rate hike in the U.S., another correction in China’s stock market, and further selling of reserves by central banks could result in that worst-case scenario of $800 (and some very grumpy gold bugs).

Why the end of the era? Here’s what the analysts say:

But price stability in Precious Metals has ended. Indeed, gold and silver prices have been in trend decline since May. Why? The passing of deflation risk, anticipation of the US Federal Reserve’s first interest rate hike, another debt resolution for Greece, and the collapse in China’s equity markets (prompting loss-covering asset sales) – have all hit these prices over 8-10 weeks. So the PBoC’s announcement last week, about China’s surprisingly low official gold holdings, was really just the latest in a string of bearish events. It’s possible that the next short-term driver in metal markets will be declining oil prices (WTI & Brent down 10-16% in 4 weeks).

 

from Royal Bank of Canada

July 21, 2015 Precious Metals & Minerals NA Gold & Silver Equities: Stress Testing the Balance Sheets (3) Equity value erodes below $1,100/oz. With gold having dipped below $1,100/oz and silver below $15.00/oz, we have once again run a balance sheet sensitivity analysis for the North American listed precious metal producers in our coverage universe over the H2/2015 to 2018 period. As highlighted in previous research, the difference for the equities in the current gold price sell-off, versus prior price declines, is that the precious metals producers now have significantly greater levels of debt (Exhibit 2).

In conclusion, the companies best positioned to operate in a $1,000/oz price environment are the royalty-streaming companies Franco-Nevada, Royal Gold, Silver Wheaton, and Osisko Gold Royalties.

The gold producers that are best positioned to withstand a sub-$1,100/oz gold price are Acacia, Alamos, Centamin, Fresnillo, Goldcorp, Goldfields, Klondex, Newmont, Randgold, SEMAFO, and Tahoe (Exhibit 1).

While a number of companies have already cut or eliminated their dividends, we believe Barrick, Centerra, Goldcorp, Goldfields, Pan American, and Yamana could reduce their dividends. Stress testing at lower gold prices after growth capital is frozen. Our base case is $1,100/oz gold & $14.50/oz silver with scenarios at $1,000/oz & $13.25/oz and $1,200/oz & $15.75/oz.

We provide a onepage summary for 35 gold producers (Page 5) that includes: (1) annual operating forecasts, liquidity estimates and key credit ratios; and (2) a discussion of our scenario analysis for each company. We assume that the companies do not draw down on their existing short-term credit facilities, as many banks are likely reviewing the credit risk of these facilities. We model similar levels of sustaining capital and assume that new mine development capital is suspended, with the exception of development capital that is more than 50% complete, such as Goldcorp’s Cochenour project and Eldorado’s Olympias and Skouries projects. Stress test highlights $1,100/oz as a critical level •

At $1,100/oz gold and $14.50/oz silver, the North American gold sector remains ex-growth. In addition to the cost-cutting measures that have occurred to date, producers will need to place their highercost mines in harvest and accelerated closure mode or on care and maintenance. We would expect to see a reduction in management and board compensation and the use of private aircraft travel curtained. And below $1,100/oz, we believe some companies could see their lines of credit reduced or withdrawn, and companies with elevated levels of debt may be forced to hedge revenues, sell streams on mining assets, and/or raise distressed equity.

At $1,100/oz, companies that would need to continue making cuts to discretionary and fixed costs to improve their balance sheets include AngloGold, Barrick Gold, Hochschild, IAMGOLD, Kinross, Pan American, Primero, Teranga, and Timmins. • At $1,000/oz gold and $13.25/oz silver, we would expect mine production to begin to contract as mines are placed on care and maintenance or moved into accelerated closure. In addition to the cost-cutting measures mentioned above, we believe a number of the gold producers would need to consider mergers to capture operating synergies or other financial benefits. At $1,000/oz, all of the gold/silver producers in our coverage universe would continue to make cuts to operating and discretionary costs and the most leveraged companies would seek alternative sources of equity. • At $1,200/oz gold and $15.75/oz silver, we believe most of the sector can sustain their current operating mines, but mines with AISC above $1,100/oz would likely go into “harvest mode” with significant development capital spending deferred. In addition, at $1,200/oz the producers can still implement cash-saving measures, with further cuts to G&A, exploration, and sustaining capital. Priced as of prior trading day’s

$1,100 gold is a critical level for North American precious metals companies

At $1,100/oz gold, most of the companies in our coverage universe are expected to continue to cut G&A, exploration, and sustaining capital spending. We could also see producers begin an accelerated closure process for their higher-cost, shorter-life mines by spending on reclamation rather than sustaining capital and mining out residual reserves over a 2- to 3- year period. Another alternative would be to place mines on care & maintenance, which would still require ongoing security/maintenance costs, although this would avoid burning cash for longer reserve life mines during a period of high sustaining capital spending associated with major waste stripping or underground development.

However, at or near $1,000/oz gold, we would expect companies to announce that their high-cost mines are being placed on accelerated closure, even mines that previously had long reserve lives given the potential for significant cash burn. We believe that most of the gold and silver producers in our coverage universe would struggle in a $1,000 gold environment if they do not defer discretionary costs, cut capital, and close cash-burning mines.

The companies that currently have the highest AISC costs include AngloGold, Centerra Gold, Detour Gold, IAMGOLD, Kinross, Newmont, Perseus, Pan American, Silver Standard, Teranga, and Timmins Gold. High-quality producers and royalty-streaming companies We believe the current gold price pullback presents an opportunity to buy gold mining equities with strong balance sheets that offer an attractive risk-reward.

In our view, in a sub- $1,100 gold price environment, the most resilient North American listed gold producers with solid yet flexible business plans and strong balance sheets would be Acacia, Alamos, Centamin, Fresnillo, Goldcorp, Goldfields, Klondex, Newmont, Randgold, SEMAFO, and Tahoe (Exhibit 1). These companies have low net debt, a low capital spending to cash flow ratio, and low-cost mines. The gold companies with the most robust business models and in a sharply lower gold price environment are the royalty and streaming companies, including Franco-Nevada, Royal Gold, Silver Wheaton, and Osisko, which have little or no debt and minimal operating and capital exposure. Exhibit 1: NA Precious Metal Producers leverage versus AISC margins clearly show

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