Attention Gold Investors! Hold on Tight, Things Are About to Get Rocky

Attention Gold Investors! Hold on Tight, Things Are About to Get Rocky

Around this time of the year, usually along with full-year results, gold miners release their reserve valuations, and this year, things are not going to be pretty. Gold has been in a bull market for the last decade or so, and as a result, the valuations of gold reserves for miners such as Barrick Gold and Newmont Mining have only gone up.

But with the price of gold registering its first yearly decline in 12 years, miners are going to have to writedown the value of their reserves, a practice Newcrest Mining has already been forced to do this year.

Taken a hit but more to come
Newcrest took a writedown of $5.5 billion earlier this year on one of its mines, when the company admitted that its reserves would not translate into as much profit as originally thought. As it turns out, this was the largest-single writedown in mining history.

Barrick has also taken a megawritedown on its delayed Pascua-Lama mine this year, which cost the company a cool $5.1 billion. What's more, Barrick also cut production forecasts, as it postponed development of it Pascua-Lama mine, which was widely touted as being the rising star in the company's mining crown. In total, Barrick reported writedowns of $8.7 billion for the fiscal third quarter.

Unfortunately, it would appear that more pain is coming Barrick's way. All mining companies place a value on their reserves. This value is supposed to represent how much each mine is worth based on the recoverable gold within the mine. Of course, to value these reserves, mining companies use an indicative gold price. So, if a company believes that its mine contains 10,000 ounces of recoverable gold and the gold price is around $1,500 per ounce, then the company can value its mine at $15 million. Of course, this is only an example.

In Barrick's case, the company's gold reserves are valued at $1,500 per ounce, and with the lower gold price, the company is going to have to readjust the value of its mines lower -- the company will have to revalue its mines to take into account the lower price of gold.

Barrick is not alone. Newmont is also going to have to take some writedowns as well. Newmont currently uses a figure of $1,400 per ounce to value its reserves. Fortunately, Newcrest uses a figure of $1,250 to value its reserves, so the company is unlikely to suffer as much as its large peers.

But how much will it cost?
How much are these writedowns likely to cost? Well, according to the Financial Times, Newmont's management has previously stated that a $100 per ounce fall in the price of gold would cut the value of the company's reserves by 7.6%. Meanwhile, Barrick's management has stated that a $300 per ounce fall in the price of gold would see the value of its reserves fall by less than 10%. At present, the price of gold is trading at around $1,230 per ounce. Miners usually understate the gold price to give them some headroom, so, if we assume a price of $1,200/oz, then Newmont is likely to see the value of its reserves fall by 15.2% and Barrick is likely to report a fall in reserve value of around 5%.

Crunching numbers
How much will this be? Well, I cannot give definitive figures as I do not have all of the information available. However, according to Barrick's 2012 annual report, the value of the company's gold-bearing assets in the Americas, Australia Pacific, and the company's subsidiary, African Barrick Gold totaled slightly less than $19 billion. In addition, capital project assets, e.g., the development of prospective gold mines, totaled $13 billion. This gives us a total of $32 billion.

As previously stated, Barrick's management believes that a $300 per ounce fall in the price of gold will cost the company 5% of its reserve value, which is around $1.6 billion, not a colossal amount. Newmont, meanwhile, reported at the end of 2012 that its reserves had a net book value of $18 billion. Its reserves are likely to fall by 15.2% due to the declining gold price, which works out to a cost of around $2.7 billion.

Now, I must stress that these figures are only estimates, a guide to what kind of writedowns these miners will be facing. Still, these numbers give a good indication as to what pain these miners are likely to suffer.

So in conclusion, all gold miners place a value on their gold reserves, and with the price of gold falling, these values are likely to be revised downward in the near future. These revaluations will affect company balance sheets as asset values fall, and the companies are likely to take multibillion dollar non-cash charges due to these asset-value readjustments. Investors need to be careful during the next few months.

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