Gold: Not The Typical Year-End Buying Opportunity

January 5, 2018

As per my previous comments, gold (GLD) had hit my $1,360 target and I was contemplating the possibility of a break above $1,375. I believed at that time the best chance for this was in September/October, because after that we would enter the typical year-end period of gold weakness. As it turned out gold made it no higher than my $1,360 target and the year-end weakness began to take hold.

I drag this same monthly chart out a few times during October to December each year and simply add on the most recent calendar year. Gold held up better than I expected this year as I believed we would bottom between $1,200 and $1,220. With the year at a close, I have updated my monthly chart and this year we can see that weakness was quite brief, with just the tail of the December candlestick dipping down to about $1,245.

I believe there are two main reasons for gold's relative strength at this year's end. There are a lot of froth and bubbles in capital markets, with bitcoin soaring, marijuana mania, and all stock market indexes up strongly this year without so much as a 5% correction. Some of this excess capital is finding its way into gold.

The second reason is that we are entering the later stages of the economic cycle. After the 2008 crash many economic pundits pointed out how weak the economic recovery was and how long it was taking, even as late as 2015/16. Trump's election victory brought new optimism and 2017 marked the year of solid economic strength in the U.S. and abroad. In the later stages of an economic cycle, inflation begins to rise, along with higher interest rates, and this is usually a good period for gold. The Fed is always behind the curve, raising rates too slowly and/or not enough.

In September, I also suggested taking part-profits in Goldcorp Inc. (G:TSX; GG:NYSE) call options, and taking profits in New Gold Inc. (NGD:TSX; NGD:NYSE.MKT) around $4.00. In general, 2017 was not very exciting for the precious metal producers as they basically traded sideways all year. This is shown below on the Gold Bugs Index (HUI), trading between 180 and 210 for the most part and ending 2017 a few points higher than where it started.

It is the time of year I like to add some gold producers to the portfolio, and will start with New Gold (NGD).

In 2017, Rainy River was a "Rodney Dangerfield" to New Gold, as the company got no respect for it, and was actually disrespected, with the cost overruns. That is now water under the bridge, and finally we are reaching the point where Rainy River will be a huge contributor to New Gold's bottom line. I will begin with putting New Gold in its current perspective, and then discuss the effect Rainy River will have.

New Gold's Q3 report revealed gold production of 82,027 ounces (including the Peak mines), and was below 2016 as higher production from the company's Mesquite mine was offset by planned lower production at New Afton, the Peak Mines and Cerro San Pedro. Cerro San Pedro's production decreased as the mine transitioned into residual leaching in June 2016. Quarterly copper production of 26.0 million pounds and silver production of 300,000 ounces both remained in line with the third quarter of 2016.Basically, growth has been stagnant the past year, making the large jump in production resulting from Rainy River a welcome development in my books.

Third-quarter operating expense per gold ounce of $601 increased relative to the prior-year quarter due to a higher proportion of sales from Mesquite. The company delivered third-quarter all-in sustaining costs from continuing operations of $610 per ounce, including total cash costs from continuing operations of $204 per ounce. All-in sustaining costs from all operations were $792 per ounce, including total cash costs from all operations of $339 per ounce. New Gold's costs are in the lower quartile among its peers, but the stress on its financial performance has been the development costs for Rainy River and the overrun costs on the same. Project spending at Rainy River during the third quarter totaled $130 million, with estimated remaining development capital of approximately $100 million, which includes project working capital post-commercial production. As shown below, in slide 12 of the company's presentation, development costs are coming to an end and will be replaced with strong cash flow from production.

On October 19, New Gold announced that Rainy River Mine achieved commercial production, approximately two weeks ahead of schedule. Its first gold pour was on October 6, 2017. The processing rate averaged 15,200 tonnes per day, or 72% of the 21,000 tonnes per day nameplate capacity. New Gold defines commercial production as exceeding 60% of nameplate capacity over a 30-day period. Importantly, for the period October 1-18, 2017, the processing rate averaged 19,000 tonnes per day, or 90% of nameplate capacity.

In Q3, New Gold reiterated its guidance for full-year gold production of 380,000 to 430,000 ounces (includes Peak Mines). New Gold recently sold Peak Mines in Australia for $58 million, and sold El Morro project in Chile earlier in the year, to focus more funds on the new Rainy River project. The new focus is a good move, and if we substract Peak Mines production and add in Rainy River, the strong production growth becomes obvious.

Peak Mines will produce about 80,000 ounces gold in 2017, with about 13 million pounds of copper. Rainy River's feasibility projects average annual gold production of 243,000 ounces with 429,000 ounces of silver. The average grade mined will be 1.44 g/t for the first nine years, compared to 1.12 g/t over the life-of-mine, so 250,000 ounces per year is a safe number to use. This means net growth, with new Rainy River production and Peak Mines being sold, will be about 170,000 ounces per year. With current production around 400,000 ounces, this equates to 42.5% production growth.

I believe New Gold's new streamlined operations, with 90% of gold reserves in Canada, will enhance performance. The Peak Mines was a high-cost producer with all-in sustaining costs of $988 per ounce for the first nine months of 2017 and $1,739 in Q3. This will be replaced by lower all-in sustaining costs at Rainy River, projected to be $765 per ounce for the life-of-mine. The company's three main mines in Canada will provide a solid foundation for growth.

  • New Afton with a mine life of 11 years

  • Rainy River with a mine life of 14 years

  • Blackwater with a mine life of 17 years

  • Mesquite, in the U.S., has 5 life-of-mine years left

  • Cerro San Pedro in Mexico is near end of life

The production growth profile with Rainy River coming onstream is very significant. I believe as production targets are met over the coming quarters, the stock will be rerated.

Since the stock got hammered the end of January 2017 on what should now be the last Rainy River disappointment, there has been a trend of higher lows. Since that $2.50 bottom the performance has been substantially better than the sideways market we have seen in most gold producers. I see some mild resistance around $3.50 and expect we could test recent highs around $4.25 in the first half of 2018.

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Ron Struthers founded Struthers' Resource Stock Report 23 years ago. The report covers senior and junior companies with ample trading liquidity. He started his Millennium Index of dividend stocks in 2003 - $1,000 invested then was worth over $4,000 end of 2014 and the index returned 26.8% in 2016. He retired from IBM after 30 years in customer service, systems and business analyst, also developing his own charting software. He has expertise in junior start-ups and was a co-founder of Paramount Gold and Silver.

Palladium, platinum and silver are the most common substitutes for gold that closely retain its desired properties.