Soak it in folks, this is the proverbial “last week of summer.” With Labor Day approaching, this is usually a slow news time for stock markets. That’s because many movers and shakers are catching the last bit of August vacation, before the beach house rental contract expires.
The price of gold is in a holding pattern — $1,660 per ounce, with silver hovering in the $30 range. Investors await news from the Federal Reserve summit this weekend at Jackson Hole, Wyo. (Tough duty for those Fed guys, eh?)
After all, there’s an upcoming election.
“It’s the economy, stupid” and all that.
Then again, when it comes to the Fed’s quantitative easing, the bloom may be off that rose.
Or to mix another metaphor, that peculiar brand of gunpowder is wet….
Let’s get down to business, and basics. A few months ago, I was in Cambridge, Mass., at Harvard University. Among other things, I attended a talk on the investment climate. In a large lecture hall, a group of senior executives from high-tech companies held court.
Part of the get-together addressed a key point that’s both a blessing and a curse to the U.S. economy. Many businesses are holding big wads of cash. Companies sell their products and services while waiting, watching and building a war chest. Day to day, firms are hiring few new bodies. Plus, managers keep capital spending on a short leash.
The good news is that — for some businesses — cash registers are ringing. The money is there, stashed in the bank. One aerospace CEO recently told me, “There’s a lot of money stuffed under a lot of mattresses.”
The bad news in all of this is that many businesses aren’t writing checks for new investment. This lack of activity is a drag on the overall economy. What’s going on?
At the Harvard conference, one CEO of a major electronics maker put it this way: “I have 36 months of revenue in the bank, and I’m proud of that. Our product cycles are 12-24 months at the outside. Success is short-lived. And if we miss on something, I need money to keep the doors open until I catch the next wave.”
Then he added, “I can handle a recession every 10 years or so. But we live in a world where we get a recession every two or three years. You come out of a bad situation and just as you start to feel the market rise, something happens to take it back down. How do you invest in this kind of economy?”
Another tech company CEO added, “As Is see it, no matter what I do, there’s a lack of growth potential. Uncertainty means that I hoard cash. Everyone is scared of the future.”
Cash Is Life
It’s back to basics. This kind of business environment forces businesses to be cautious. It drives capital discipline. Cash is life. Lack of cash is… well, it’s not pretty.
And this isn’t just a U.S. phenomenon. Hoarding cash happens in Canada, too. In fact, recently, Mark Carney, governor of the Bank of Canada, urged Canadian companies to open their checkbooks and spend hundreds of billions of dollars that are sitting in bank accounts.
According to Gov. Carney, there’s too much idle capital. Companies are simply not spending. If Canadian firms can’t think of a place to invest money, said Gov. Carney, then they ought to return it to shareholders in the form of dividends or share buybacks.
That’s easy for Gov. Carney to say. Once you spend it, it’s gone unless you make it back. And what’s the plan to make it back? It gets back to the perception of opportunity and lack of confidence in the future.
The business environment actually reinforces the capital discipline of tech companies. Heck, if the Bank of Canada needs more money, it can just print it. If tech companies print money, that’s counterfeiting. (It’s good to be a central bank, eh?)
The Basics — Now Resource Players Cut Back
Tight wallets aren’t limited to tech companies. The basics are basic for a good reason. More and more resource players are announcing major capital cutbacks, despite decent pricing and respectable margins for many commodities — for now. It gets into that uncertain future thing. It gets back to the basics.
For example, mining giant BHP Billiton (BHP) recently confirmed that it would postpone or scale back capital projects valued cumulatively at over $50 billion. This has been in the rumor mill for several months, but now it’s official.
One major BHP cutback is at one of the world’s largest uranium-copper plays, Olympic Dam, in Australia. According to BHP CEO Marius Kloppers, “If you have a very high Australian exchange rate, if you have got very high capital costs at this very moment… you effectively lock in the economics of the project in an unfavorable way.”
That’s a useful way to think about resource investing. It gets back to the basics. The economics of any major project — the costs per ton, and much more downstream — are the heart and soul of protecting a company’s balance sheet. In other words, Mr. Kloppers is looking ahead many decades, over the long life of a large mine like Olympic Dam.
Mr. Kloppers doesn’t have 12-24-month tech product cycles. In the resource world, that would be a true luxury. No, if BHP misses the economics on a mining project, it has a bad situation that could drag the company down for many years to come.
Overall, BHP is obliged to operate in terms of current economics projected out over generations. BHP has to recover its capital investment back year by year, over a very long time. It’s a different version of that old expression, “The future is now.”
At the same time, if BHP doesn’t invest near term in Olympic Dam, that makes a better copper market downstream for other purveyors of the red metal – indeed, there are a lot of nice looking, cheap copper miners in the market these days.
Capital Discipline at Big Gold
Let’s look at another example of protecting the future, that of the world’s largest gold producer, Barrick Gold (ABX: NYSE). A few months ago, Barrick’s board abruptly fired then CEO Aaron Regent and promoted CFO Jamie Sokalsky to the top job. The new guy has a mandate to reset Barrick operations, build up the bottom line and improve market perceptions.
It’s back to basics at Barrick. Over the past month, Mr. Sokalsky has announced a retrenchment across the entire company. He lowered Barrick’s long-term gold production targets and identified a new focus on investor returns, versus only worrying about the output of ounces.
Look back. The price of gold has moved upward year over year for over a decade. It’s been easy (too easy!) for companies to fall into the trap of “no price is too high” to pay for more gold output. But now at Barrick, it’s time for different thinking.
“Growth for growth’s sake,” according to Mr. Sokalsky, is the wrong strategy in the gold mining industry. Actually, that’s quite an admission. That choice of words gives a hint of what’s been going on behind the doors for quite some time. Then again, for much of the past decade, the share markets rewarded CEOs who pounded the podium and promised “more ounces.”
Now it’s time to pay attention to the economics of each ounce. In a recent call, Mr. Sokalsky said, “The tide has turned. Investors are much more focused on greater returns, free cash flow [and] return of capital… I think the environment and investor demands have accelerated a process of the industry being more disciplined in how they’re managing their business.”
Barrick’s new, more strategic, disciplined view of capital is refreshing. It’s particularly good considering that we’re well into a time when share performance has been in the dumps, while cost inflation is out of control. Better late than never.
Barrick’s new emphasis on capital discipline will play out in the way it approaches high-risk, remote, multibillion-dollar projects. Barrick’s focus is shifting to better capital management, with improved investor returns. As a leader in the gold industry, Barrick’s example should strongly influence other companies.
Barrick Hit a Wall
Barrick hit a wall in the second quarter of this year when it reported stunning cost inflation at its immense Pascua-Lama project, high in the Andes, on the Chile-Argentina border. According to Barrick, the former cost estimate of $4.7-5.0 billion, as of last year, will likely be as high as $8.0 billion.
Looking back to an earlier time, in the developmental heydays of 2004, the Pascua-Lama construction estimate was $1.5 billion. When the Barrick board approved the project in 2009, the development estimate was just shy of $3 billion. So now, at $8 billion, costs have climbed 175-500%, depending on when you set the base line.
According to Mr. Sokalsky, Barrick made mistakes at Pascua-Lama. Among other things, Barrick has traditionally hired contractors to build its mines. But at Pascua-Lama, Barrick went out on its own. This led to bad estimates of how complex it is to build a large mine at high altitude in extreme weather conditions. Add in eye-popping increases in Argentine labor costs — hourly rates up by 54% just this year — and things have gotten worse.
According to Mr. Sokalsky, “Our overall project-management structure let us down.” And now it’s time to tighten up. Back to basics.
Barrick’s new focus on capital discipline means that it will scale back development of two other mega-projects in its pipeline, Cerro Casale and Donlin Creek, unless the overall economics improve in coming years.
The Donlin Creek asset is huge — over 30 million ounces. It’s attractive for long-term investors with patient money. The Donlin gold isn’t going anywhere and the project will get another look-see when gold prices resume an upward track. It shouldn’t be that long, considering that inflation is built into the whole monetary game.
The take-away from all this is that there’s a new business model hitting big gold miners. The salad days of spend, spend and spend — and deliver more shiny ounces, no matter the economics — are over. It’s been a long time coming, with too much capital spending for too little return.
Looking ahead, it’s back to those basics of capital discipline and making money. The companies that deliver on the concept will get the most love and affection from investors.
Plus, there’s another upside here. With fewer ounces of gold coming out of holes in the ground — and each ounce no longer being heavily subsidized by the shareholders — the long-term price of gold will likely firm up.
That’s all for now. Thanks for reading.
Best wishes…
Byron W. King
Source: Daily Resource Hunter
