The Incredible Ironly of Paltry Gold Profits
What will it take for gold miners to finally reap those blockbuster earnings we would expect when prices are this high and costs this low?
This article explores the nagging issue of currency losses and derivative hedges as they relate to gold miners, and the stinging irony that they present in an asset class sought for their very protection from those same financial ailments.
On the surface, Yamana had an amazing quarter: reaching record production as projects are ramping up nicely, achieving costs of just $213 per ounce after silver and non-copper base metal credits, keeping copper costs below $1 per pound, and divesting higher-cost projects deemed outside the core. And yet, the adjusted earnings of $94.9 million that so delighted the analysts with a 44% beat is not the number that comes home to roost with shareholders. No, net earnings were just $9.6 million ... 90% lower than the adjusted earnings.
Something is clearly wrong when 90% of your earnings are disappearing to these types of unrealized losses and foreign exchange impacts. Shareholders deserve to know more about what to expect on this front going forward, and how a repeat of such enormous quarterly impacts can be avoided.
Don't get me wrong ... I still think Yamana is one of the very premier choices in the gold mining sector, but these results provided a perfect example to discuss some important matters that have been bothering me about the miners for some time. They might be unhedged with respect to gold production, but as long as shareholders have to withstand derivative and currency losses on this scale, they might as well be hedged ... the result is the same.
I would love to see some accounting that indicates how the quarter would have turned out without any hedges whatsoever (i.e. if the company had engaged in no risk management techniques whatsoever). Indeed, a retroactive analysis going back several quarters would be fascinating. I think the cumulative drag of derivatives and ineffective mitigation of currency fluctuations have held the miners back significantly during the past year.
To know your miners, make sure you know their hedging activities.
"The weakening U.S. dollar reduced Yamana's second-quarter net by more than $60 million, including foreign-exchange losses and revaluation of future tax expenses. Fools will appreciate the stinging irony of investments conceived as shelter from a falling dollar having their returns ravaged by that very outcome. Naturally, Yamana hedges against currency fluctuations using derivatives."
"Yamana holds interest-rate-swap derivatives with a notional value of $444.8 million to reduce variability on an adjustable-rate debt facility. The stark irony of investors fleeing the impact of the global derivatives meltdown through exposure to gold miners -- only to find their earnings assailed by yet more derivatives -- is not lost on this Fool. All told, unrealized derivative losses for Yamana have totaled $81.8 million this year."
And here is the bottom line:
"I continue to believe that patient Fools will experience robust leverage to increases in gold prices. The remaining obstacles, it would appear, are the very same challenges plaguing the rest of the financial system: toxic derivatives and the crashing dollar."
Discuss, and Fool On!