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Gold Mining Companies Continue to Disappoint, but Not for Long

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The managements of bigger gold mining companies -- such as Barrick and Newmont -- are trying to entice investors interested in high-dividend yields.

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It is an endless debate for investors interested in gold. Should they buy a direct play on the gold price, either gold bullion itself or even so-called paper gold with an ETF such as the SPDR Gold Shares (GLD)? Or should they invest into gold equities, particularly the larger, higher quality gold mining companies?

Recent history suggests the answer is gold itself. According to Citigroup, physical gold has outperformed global gold equities 120% of the time over the past five years. Stocks of the bigger gold mining firms seem to react adversely to bad news (which is normal), but the problem is they react with no more than a yawn to good news. These type of stocks are contained in the Market Vectors Gold Miners ETF (GDX).



Evidence of this trend can been see in the latest news to hit the industry... the slowdown in expansion as recently signaled by the world's largest gold producer, Barrick Gold (ABX). The company's stock has fallen by more than 30% over the last year due to cost overruns at major projects. The latest blowup in costs of up to $3 billion occurred in its estimate for development of its flagship Pascua-Lama project on the border of Chile and Argentina. The project may now cost up to $8 billion.

In addition, Barrick decided to shelve the $6 billion Cerro Casale in Chile and the $6.7 billion Donlin Gold project in Alaska. Barrick is not alone in its thinking among the major gold producers. The CEO of Agnico-Eagle Mines (AEM), Sean Boyd, recently said "The era of gold mega-projects may be fading. The industry is moving into an era of cash flow generation, yields and capital discipline."

Fair enough. But are gold mining companies' managements walking the walk about yields or just talking the talk? Last year, many of the larger miners made major announcements that they would be focusing on boosting their dividends to shareholders in attempt to attract new stockholders away from exchange traded vehicles such as GLD, which have siphoned demand away from gold equities. Barrick, for example, did boost its dividend payout by a quarter from the previous level. Newmont Mining (NEM), which has also cut back on expansion plans, has pledged to link its dividend payout to the price of gold bullion.

So in effect, the managements at the bigger gold mining companies (which are having difficulties growing) are trying to move away from attracting growth-only investors to enticing investors that may be interested in high dividend yields. This is a logical move.

But rising costs at mining projects may put a crimp into the plans of gold mining companies as they may not have the cash to raise dividends much. And they have done a poor job of raising dividends for their shareholders to date. In 2011 the dividend yields for gold producers globally was less than half the average for the mining sector as a whole at a mere 1.3%. Their yields are below that of the base metal mining sector and the energy sector.

It seems like management for these precious metal companies have the similar emotional response shareholders have when they are in a winning position. When the investor's brain has experienced a winning streak and is happy, it automatically goes into preservation/protection mode. What does this mean? It means management is going to tight up spending to stay cash-rich as they do not want to give back the gains during a time of increased uncertainty. Smaller bets/investments are what the investor's brain is hardwired to do, which is not always the right thing to do….

Looks like there is still a lot work to be done by gold mining companies to improve returns to their shareholders. But with all that set aside, it is important to realize when physical gold truly starts another major rally. These gold stocks will outperform the price of gold bullion drastically for first few months.



Gold Miner Trading Conclusion

In short, last week I discussed how gold has been forming a major launch pad for higher prices over the past year. Gold bullion has held up well while gold miner stocks have given up over 30% of their gains. If/when gold starts another rally I do feel gold miner stocks will be the main play for quick, big gains during the first month or two of a breakout. The increased price in gold and value of the mining companies' reserves could be enough to get management to start paying their investors a decent dividend, which in turn would fuel gold miner shares higher.

Both gold and silver bullion prices remain in a down trend on the daily chart but are trying to form a base to rally from; this may start any day now. Keep your eye on precious metals going into year end.

Editor's Note: Chris Vermeulen offers more content at his sites, TheGoldAndOilGuy.com and Traders Video Playbook.
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No positions in stocks mentioned.

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