Newcrest weathers a writedown tempest

The gold miner's massive writedowns are slightly misleading, given the sector's history, and with chief Greg Robinson's commitment to cut costs it's not surprising Newcrest has rallied.

The sharemarket may not have liked Newcrest Mining’s $6.2 billion of writedowns or near-60 per cent fall in underlying earnings but it did react positively and quite sharply to what Greg Robinson is doing in response to the sea-change in the settings for the gold mining sector.

The writedowns had, of course, been well-flagged as had the steep fall in underlying profitability, which last year was just above $1 billion but which slumped to $451 million in the year just ended.

Lower production and sales volumes and a gold price more than 20 per cent lower than at the start of the year and closer to 25 per cent off its peak last year were inevitably going to ravage Newcrest’s results, as they have the results of the other big gold miners.

Goldcorp, Barrick and Anglo Gold and others have also announced big writedowns of asset values and much lower profitability as the whole sector has been destabilised by the abruptness and severity of the end of the bull-run in gold that lasted more than a decade.

The writedowns, while massive – the major miners have now written off about $US20 billion of value – are somewhat misleading.

There has been a considerable amount of consolidation activity within the sector over the past decade and more as the bigger miners pursued the premium investors seeking scale and liquidity and deployed the premium share prices generated by the bullmarket for the metal, which rose nearly 400 per cent between 2000 and its peak last year.

They issued scrip (gold sector acquisitions are, as Newcrest’s acquisition of Lihir Gold was, almost always predominantly done in scrip) that in hindsight could be said was issued at inflated prices and the writedowns merely reflect the deflation that has occurred. Because of the gold premium there wasn’t an opportunity cost because they weren’t going to use their scrip to acquire anything other than gold assets.

The more fundamental issue is their underlying profitability at current gold price levels. In common with the rest of the resource sector the gold miners allowed their costs to escalate during the boom years and, because it was profitable, brought more high-cost reserves and production into their portfolios.

They are all now busily trying to cut costs, as is the entire resources sector, and are taking their higher-cost reserves out of production. Robinson is doing exactly that and is also planning to slash capital expenditure from almost $2 billion to $1 billion as the focus on cash flow becomes quite intense.

Newcrest said today production and costs would be actively managed to target a free cash flow neutral or positive outcome for the company in the current environment. At a gold price of $A1450 an ounce, it said, all operations were projected to be free cashflow neutral or positive in 2013-14.

The gold price today is about $A1445, so the current position is quite tight and, with net debt of $4.1 billion and gearing about twice the level Robinson believes is appropriate for an unhedged gold producer, the focus on cash and its retention – Newcrest isn’t paying a final dividend – is sensible and necessary.

There are those within the industry that say that it needs a price of closer to $US1500 an ounce to be sustainable in an environment where the miners are exploiting higher cost reserves than they were in the past.

There are a number of possible explanations, or strands to the explanation, as to why the price cracked and has fallen so steeply, although the catalyst for the steepest part of this year’s fall was the first muttering among US Federal Reserve Board Open Market Committee members about the eventual exit from their quantitative easing program. US bond rates spiked, the US dollar strengthened, equity markets fell – and the gold price plummeted.

Part of that explanation for the severity of the fall has been the dumping of exchange-traded gold fund holdings by investors, with some estimates that about $US60 billion of funds have been withdrawn from the ETFS, which have themselves lowered their exposure to the metal by about 25 per cent, or about 640 tonnes, since the start of this year. There’s also been a lot of activity in futures markets – it’s the selling of 'paper' gold that appears to have driven the price spiral.

At a fundamental level the response of the gold miners in withdrawing marginal production ought, as it should in other commodities, eventually affect and improve the balance in physical supply and demand, providing central banks don’t disgorge their holdings.

There is also a longer term question as to whether the US, Europe and Japan can ultimately wean themselves off their extraordinarily expansive monetary policies while controlling inflation as growth eventually (hopefully) is rekindled in their economies. Any doubts about their ability to avoid significant outbreaks of inflation would generate more support for the gold price.

In the meantime, while hoping for better times and a better gold price, the producers like Newcrest have no option but to manage for a continuation of the current settings, or something worse.