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Gold Going East, Revenue Going West
Posted by: Patricio Kehoe (IP Logged)
Date: September 9, 2013 05:21PM

Gold importing giants India and China have increased their imports by 48% and 70% respectively, during the first half of 2013, compared to the same period in 2012. Considering this positive outlook for gold producers, the U.S.-based firms Freeport-McMoRan Copper & Gold (FCX) and Newmont Mining (NEM) could be looking at a brighter future.

Diversification Has Its Benefits

Freeport-McMoRan Copper & Gold is one of the largest publicly traded copper, gold and molybdenum producers. The company's main asset, the Grasberg mining complex in Indonesia, boasts the most significant recoverable copper and gold reserves in the world. In addition, the firm recently expanded its portfolio by acquiring the U.S. gas and oil firms Plains and McMoRan. Despite some uncertainties regarding copper prices, John Paulson from Paulson & Co. increased his stake in the firm, by adding over 72% to his current shares.

The slowdown in Chinese growth, as well as the large investments made by competitors, is set to bring down copper prices in coming years. Nevertheless, Freeport’s attractive cost position should help soften the effects of declining prices. In addition, increasing Chinese and Indian gold imports will help the firm maintain a steady flow of revenue. Being one of only three molybdenum producers worldwide, a mineral used for metal alloys, will help mitigate the effect of falling copper prices further. Some controversy has arisen with the acquisition of Plains and McMoRan, since it required a huge investment. Yet analysts project future earnings from the stride into the energy sector, which will help gain back the funds invested and repay the firm’s existing debt.

Freeport is financially strong, with profits exceeding $6.4 billion and an impressive operating margin of 32.3%. F FFreeport is currently trading at 11.1 times its earning ttm, which translates to a 16.5% price discount relative to its industry peers. Despite projections of lower copper prices in the future, the firm is bound to benefit from the increase in gold demand stemming from China and India.

Uncertain Future Projects

Newmont Mining, the biggest U.S. gold producer, has assets on four different continents and boasted 99 million ounces of proven gold equity reserves in 2012. The recent sale of its stake in Canadian Oil Sands has freed up additional funds, yet these must be directed towards debt repayment if the firm is serious about its finances. It is worth noting, that Julian Robertson of Tiger Management has recently sold his entire share of the firm.

In the short term Newmont seems like a troubled company, with rising operating costs and declining production rates. Adding further uncertainties, the Hope Bay project in Canada and the Peruvian Conga development have been put on hold. In the long run, however, production levels are expected to rise as the new Akyem mine in Ghana and Batu Hijau in Indonesia reach full potential. Furthermore, the production at firm’s mines in Nevada can be bolstered at low costs, due to investments made in infrastructure over the years. Newmont’s largest problem lies in bringing new projects on line. In particular, controversy surrounding the firm’s mining practices, has led to growing opposition from local governments.

Newmont’s financial stability is moderate, with debt on the rise. Negative cash flow stemming from delayed projects and rising operating costs, will take a toll on the firm’s finances in the near future. Currently trading at 9.2 times its earnings ttm, Newmont is currently available at a 30.8% price discount relative to its industry peers. Despite being an industry giant, the firm has yet to prove it can improve its production rates and thus, I feel just as pessimistic about this stock as Julian Robertson.

Better Be Safe Than Sorry

After comparing Freeport and Newmont, one thing becomes clear: Freeport is the safer investment option. Newmont’s dependence on gold prices makes it very vulnerable to market cycles, and current difficulties at new projects are worrisome. Freeport on the other hand is set out to reap the full benefits of recovering gold prices and elevated demand from China and India, making John Paulson’s optimism understandable.

[b][/b] Disclosure: Patricio Kehoe holds no position in any stocks mentioned

Guru Discussed: John Paulson: Current Portfolio, Stock Picks
Stocks Discussed: FCX, NEM,
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