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Investors Are Leaving Gold, and Gold Miners Are Cutting Back

Tuesday - 8/27/2013, 7:24am  ET

Hedge funds and other speculative investors have shifted their investments away from gold to equity markets yielding higher returns. A strengthening U.S economy made the yellow metal less valuable to investors, which prompted significant outflows from gold-backed ETFs. In late June, following news that the Federal Reserve may decide to taper its bond purchasing program, gold prices plunged to $1,180/oz, the lowest point in three years. Canadian gold miners such as Barrick Gold and Goldcorp announced large asset writedowns and cost-cutting programs in response to lagging gold prices.

Improving cash flows
In Barrick Gold's second quarter report, the company outlined a plan to reevaluate all its mining assets that produce gold above an all-in sustaining cost (AISC) of $1,000/oz. About 25% of Barrick's mines operate above this level. If an asset runs above $1,000/oz, management said they are prepared to change mine plans and suspend, close or sell the asset to improve cash flows. High-cost mines have prevented the company from generating positive cash flow and profits in the low-priced gold environment. This renewed focus will help the company distance itself from relying on higher gold prices to manage its business.

On August 22, Barrick reached an agreement to sell three of its Yilagarn South assets in Western Australia to industry rival Gold Fields Ltd. for $300 million. The Darlot, Granny Smith, and Lawlers mines produced an aggregated 196,000 ounces of gold at an AISC of $1,145/oz in the first half of 2013. The sale shows Barrick's commitment to remove high-cost mines from its asset portfolio to bolster cash flow and profits. Barrick intends to use the proceeds of the sale for general corporate purposes and debt repayment.

Cost-cutting programs
Goldcorp, Canada's largest gold miner after Barrick Gold, implemented companywide spending reductions to limit its exposure to the current gold environment. Gold miners have become conservative with spending their cash on exploration and expansion projects. Miners cannot afford to take the risk of investing in assets that may not generate sufficient cash flows and profits.

Goldcorp has chosen to defer 2013 and 2014 capital expenditures at its Cerro Negro project in Argentina as well as Éléonore and Cochenour projects in Canada. These measures will reduce 2013 capital expenditures by approximately $200 million to $2.6 billion, according to the company. Goldcorp doesn't expect the delay to affect project schedules or initial gold production. In addition, it lowered exploration spending targets for 2013 to $200 million from $225 million and revised its general and administrative expenses to $164 million from $180 million. 

Barrick joined Goldcorp in aggressive cost reductions to offset the cash flow impact of the declines in metal prices. Barrick's capital and cost reductions totaled $2 billion in the first half of this year. Barrick has cut about $4 billion of previously budgeted capital expenditures over a four-year horizon without dampening gold production projections. Barrick's and Goldcorp's cost-cutting programs will greatly bolster their balance sheets. When gold recovers, they may deploy their preserved cash into new mining and exploration activities to expand growth.

Quantitative easing and SPDR Gold Shares
Fed Chairman Ben Bernanke says the bank expects to trim its $85 billion monthly bond-buying program if the U.S economy shows signs of sustainable growth. Referred to as quantitative easing, the program keeps interest rates low to stimulate U.S economic growth. His statements have rattled gold futures and gold-backed ETFs, which in turn affects gold miners such as Barrick Gold and Goldcorp.

The World Gold Council reported that hedge funds and speculative investors have been exiting their gold-backed ETFs positions, such as SPDR Gold Shares , because of a healing U.S economy. SPDR Gold Shares, the world's largest gold-backed ETF, provides investors access to gold investments without the vagaries of the gold futures market. The ETF has recorded significant outflows, reaching $11.5 billion in the second quarter. 

"The prospect of the U.S government tapering quantitative easing by the end of 2013 had a disproportionate downtrend impact on the gold price as some investors in ETFs saw their key rationale for seeking a safe haven in gold fade," the World Gold Council report said.

During the second quarter, over 400 tonnes of gold flowed out of ETFs because of signs of a strengthening U.S economy and the Fed loosening its monetary policy. Source: World Gold Council

Investors will closely analyze economic data, such as U.S unemployment claims to monitor whether the Fed will ease or tighten its monetary policy. If disappointing economic data surfaces, equity markets fill with uncertainty. Investors could flock to gold futures or gold-backed ETFs as a safe haven to hedge against a weaker U.S economy, shooting precious metal prices higher and causing gold miners to generate higher returns from their lower-cost assets.

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