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Time to Buy That Falling Golden Knife?

Sunday - 4/21/2013, 1:49pm  ET

The world of gold is quite lively these days. Sudden mine closures and falling gold prices are causing havoc in the market. Gold is a safe-haven, a place of security that people look to in times of political and financial upheaval. Until another disaster strikes, gold's prospects look rather dim. 

Gold Price in US Dollars data by YCharts

Why is the price of gold falling? 

The above chart shows the VIX; a measure of volatility and risk. When the VIX is high there is a large amount of instability in the market. In the past year the VIX has consistently stayed below 26 and risk apatite has increased, decreasing the demand for safe havens like gold.

A recent report (pdf downloads on click) by the World Gold Council shows how investor and central bank purchases of gold have grown from a net negative in 2003 to a net positive. This means that fickle investor risk preferences are driving more volatility into gold prices. 

What does this mean for the miners? 

Barrick Gold  is one of the world's most public gold miners. Recently the Chilean government paused work at its Pascua-Lama mine on the Argentinean-Chilean border. The company can still continue some work in Argentina, but this recent legal action is a major setback for the firm. 

In 2012 the all-in sustaining cash cost was $945 per ounce. Other miners have lower cost operations, but at least Barrick is still profitable. Its costs are still a couple hundred dollars away from the August, 2013 futures price around $1400. 

This company is a very speculative investment and it is not clear when it will stabilize. It has a major debt load with a total debt to equity ratio of 0.64. It may be forced to sell off assets if gold prices do not improve. Even though it is trading at a discount with a price to book ratio of 0.81, this company is too risky for comfort. 

In many ways Yamana Gold  is in a better situation than Barrick. It has almost no debt with a total debt to equity ratio of just 0.10. Chile is a very well-run nation and 47% of Yamana's 2012 production came from the Andean country. Chile's decision to temporarily stop Barrick's production is really a positive. It shows that country has grown and is able to solve grievances through the legal system. When a nation is unable to work out grievances through established legal means, then tensions can grow until nationalizations and coup d'états occur. 

On the negative side, 16% of Yamana's 2012 production came from Argentina. This country recently nationalized a number of oil and gas assets and it could do the same in the mining sector. As Yamana's mines in the stable nation of Brazil come online, the firm's level of geopolitical risk will gradually decrease. With an expected 2013 all-in sustaining cash cost to come in below $800 per gold equivalent ounce, Yamana's profits are more secure than Barrick's. 

Freeport-McMoRan Copper & Gold  is an interesting company. Copper is its main product with gold coming in at a distant second. When calculating its expected 2013 average unit net cash costs of $1.35 per pound, it uses copper as its base unit. With August, 2013 copper futures around $3.22 per pound, the company should be able to maintain acceptable margins. Recently it has also bought some oil and gas assets to diversify out of the mining industry.

The copper market is not expected to do much better than gold over the short term. In 2013 a production surplus of 460 thousand tonnes is expected. On the positive side, Freeport-McMoRan's Indonesian ore grades are expected to increase in 2013.

The company has little debt with its total debt to equity ratio of just 0.20. Its diverse operations and interests outside of the gold market help it to maintain profits and earnings. With a profit margin of 22.1% and return on investments of 18.9%, the company is more profitable than Barrick or Yamana. 

Conclusion

The price of gold is falling and highly indebted companies like Barrick may get stuck between a rock and a hard place. When Europe's debt crisis returns to the front page, Yamana will be a good gold miner to consider with its low debt and relatively low all-in sustaining cash costs. Freeport-McMoRan's diverse operations provide more stability and security. Overall, it is the best option for risk-averse investors who don't want to try and guess tomorrow's gold price. 

This article was originally published as Time to Buy That Falling Golden Knife? on Fool.com

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