By now, most everyone who follows the financial markets even passively is likely aware of the recent plunge in precious metals prices. I have written articles sharing my thoughts on gold and the gold mining stocks in light of the epic price drop. I would now like to turn my attention to the bond side of the equation.
In my portfolio, I own the bonds of Newmont Mining and AngloGold Ashanti Holdings Finance. Also, for many months, I have had my eye on the April 1, 2042 maturing, 5.25% coupon Barrick Gold notes (CUSIP 067901AH1) as well as the September 1, 2041 maturing, 6.875% coupon Kinross Gold notes (CUSIP 496902AK3). But the price was never right. As I watched the stocks of gold miners (Barrick and Kinross included) collapse during the month of April, I was hoping the opportunity would present itself to purchase these bonds on a decent pullback. After all, with the price of gold and gold mining equities in free fall, surely investors could expect a decent spread widening in the bonds, right? Not quite.
Impressively, Kinross Gold’s 2041 maturing notes are essentially unchanged during the stock’s 37.33% decline in the first 13 trading days of April. Given that long-term Treasury yields declined during that time, there has been some spread widening in the Kinross Gold notes. But it wasn’t enough to cause a pullback in the bond’s price. Instead, the bond continued its choppy, sideways action with offer prices largely remaining in the 105 to 107 region.
Admittedly, Barrick Gold’s 2042 notes had been creeping lower in price since the beginning of the year. But during the first half of April, when Barrick Gold’s stock plunged more than 33%, the price of the notes was essentially unchanged. It finally broke by a couple of points on April 16, the day before Moody’s publicly announced it had placed Barrick’s ratings on review for downgrade. And this past Friday, there was actually an opportunity to purchase the notes under par, which is something I hadn’t seen before.
The same type of price action holds true with Newmont Mining’s and AngloGold Ashanti’s long-term bonds. During the month of April, there has been nothing noteworthy in the price action of those bonds, despite gold prices and their stock prices falling off a cliff. Why, given plunging gold prices and relentless selling in gold mining stocks, have we only seeing a minor spread widening in the longer-dated bonds of the aforementioned companies? The Moody’s press release announcing a ratings review of Barrick Gold provides a clue.
Moody’s had this to say in the press release:
“The review arises from the challenges facing the company on its Pascua Lama project following the Chilean government’s injunction to halt construction activity on the Chilean side of the project and the uncertainty this creates with respect to the cost and timing of this project. The review is also attributable to the flat to declining production profile in 2013 relative to 2012 and increasing cost base, and likelihood of greater than expected negative free cash flow particularly given the high capital expenditure profile in 2013 and possibly 2014. The recent collapse in gold prices and expected increase in volatility is also a factor in the review although not the principal driver as our sensitivity scenarios are run at prices lower than those at which gold is currently trading [emphasis added].”
While equity investors may have been pricing in earnings expectations based on gold prices being a couple hundred dollars higher than they are today, Moody’s stated that its “sensitivity scenarios are run at prices lower than those at which gold is currently trading.” On the date of that press release, Gold was trading under $1,400, and Moody’s stated that its sensitivity scenarios for Barrick Gold are run at prices lower than that. In other words, the gold price decline is not good for the company (it, along with the decline in copper prices, was probably the trigger to initiate the review), but Moody’s had previously already tested Barrick’s financial risk in the event of an even greater decline in the price of gold. What might the price be at which Moody’s ran its sensitivity scenario for lower gold prices? Based on the following, my guess is $1,200 per ounce:
In the March 29, 2012 press release, “Moody’s assigns Baa1 rating to Barrick’s notes offering,” the rating agency had this to say: “The stable outlook also incorporates our expectation that should gold and copper prices retreat materially below $1200/oz and or $3.50/lb respectively, Barrick would materially throttle back its development expenditures.”
The price of gold has gotten closer to the likely pain threshold for bond investors in gold mining companies. But, as the Barrick Gold example illustrates, we are not quite there. Should gold prices hold steady at these levels or even rise, bond investors will probably need to root for higher benchmark Treasury yields (lower benchmark prices) in order to have the opportunity to purchase most gold mining bonds at lower prices. And if gold prices continue declining, bond investors wanting to buy a dip in gold mining bonds will need to hope that Treasury yields don’t decline by an amount greater than the increase in spreads.
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