COMMENTARY — Of cash flow and gold prices

Analyst John Lydall of First Marathon Securities, writing in The Senior Canadian Gold Producers, 1993 Preview:

In looking ahead, it is important not only to focus on likely earnings but also on each company’s underlying cash flows.

Cash flow is a complex topic. In our opinion, analysis on gold mining companies tends to focus too much on the gross cash flow from operations without spending enough attention as to what happens to this cash afterwards. There can be absolutely no question that the David Bell and Williams mines at Hemlo, Ont., have been highly successful operations in that they have produced excellent cash flow to their owners.

However, the success did not prevent one of the co-owners of these mines, International Corona, from facing financial problems, prior to its merger with Homestake Mining. Corona’s problem was not a lack of cash flow from its main mines; it was the difficulty that the company had in reinvesting the cash flows in profitable ventures.

Corona has certainly not been the only company to face these problems. In the U.S., Battle Mountain has so far been unable to repeat its success at the Fortitude mine. Pegasus Gold announced its second major writedown in three years. In Canada, Placer Dome took a $300-million writeoff on its ill-fated investment in Mt. Milligan.

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From The Bank Credit Analyst’s Outlook 1993:

Gold has ignored the hyperinflation and continued disintegration of the former Soviet Union and other catastrophes in recent years. So far, none of these shocks has produced the sort of policy errors and monetary excesses that occurred in the 1970s.

The threat of continued global turmoil, the accumulated pain from deflation in recent years (and hopes for an inflationary outcome) and the possible shift into aggressive protectionism will likely increase investment demand for gold and help to maintain a floor under prices.

Remember that gold prices have been roughly flat despite the severe deflationary pressures and the more recent rise in the dollar. This base-building phase in gold prices, combined with the likelihood that global geo-tensions will escalate, could be setting the foundation for higher gold prices in the coming years. In other words, we would rate the secular trend in gold prices as flattening out after falling during most of the 1980s.