July 23, 2015

Involvement in less regulated markets comes with its own risks. Markets participants were reminded of that when in the early hours of Monday, the 20th of July, the price of Gold plummeted by just over $45 an ounce (-3.9%) in less than a minute just before the market opened in China. This price action, caused by a massive sell order of $2.7 billion in Gold futures, looks an awful lot like market manipulation since no one in their right mind would try and sell such a large amount so quickly at the lowest liquidity point of the day. If a short-seller with deep pockets wanted to re-price Gold significantly lower, he would follow exactly the same modus operandi.


For Gold miners, this is of course bad news. After a golden decade (2001-2011) – no pun intended – when the market rewarded aggressive growth over cash flow generation and financial discipline, their fortune has changed dramatically. As the market for Gold peaked just below $2000 per ounce, investors came to the realisation that despite the yellow metal being in excess of 6x higher than 10 years before, Gold miners’ cash flow generation in aggregate was flat.

Fast forward 3 years and the situation has deteriorated quite dramatically. The chart below (courtesy of Goldman Sachs) shows the all-in cost of production (including net debt and interest due as well as operational expenses) for the major players of the industry. In effect, this shows that prices per ounce below $1050 would mean that an overwhelming proportion of Gold miners would be making a loss. The top 10 global miners also show leverage ratios (debt: equity) in the region of 100% on average. As the odds of higher interest rates in the US increase, access to financing and interest payment should worsen, adding financial stress to an already challenging operational situation.


Unsurprisingly, investors have started voting with their feet as the price of Gold approaches the $1050 – $1100 territory. Between August 2011 and June 2015, Gold miners showed a Beta of 1.6x to the price of Gold. In practice, this means that when Gold sold off by $1, Gold miners sold off by an average $1.6.

Since the beginning of the month however, this sensitivity has doubled, as Gold miners now sell off by an average $3.1 for each dollar lower in the price of Gold. This makes sense, since each dollar lower in the price of Gold exponentially increases the risk of insolvency, and ultimately bankruptcy, of these companies.


In due course, distressed investors with the nerves to get involved will be able to acquire Gold-related assets at a significant discount to fair value. The day of reckoning approaches, but things will probably get worse before they get better. Especially since the recent price action will in all likelihood spur the deep-pocketed trend-following community to increase their short positions, adding incremental pressure for lower prices to an already very weak market.