Seymour Schulich probably saved Newmont Mining with a single stock trade.
In October 2004, Schulich came to the simple realization that even though prices had already doubled over the preceding two years, oil's cost had to rise much higher since demand continued to outstrip supply.
As the chief of Newmont's investment bank, Schulich knew this was a major problem for his company.
You see, oil prices are a big part of the cost of mining. Huge trucks and machines mostly burn diesel fuel. Even the tires are made of oil. As a gold miner, Newmont would see its earnings suffer from continued oil price hikes.
Faced with the potentially crippling rises in mining costs, Schulich hit on an elegant solution: The perfect hedge against rising oil prices was to own a stake in an oil company.
So Schulich purchased for Newmont 6 million shares of Canadian Oil Sands Trust – a producer with vast reserves of low-quality bitumen. Schulich figured as oil prices rose, oil-sands assets would go from marginal to very profitable. As a result, the shares of bitumen producers, like Canadian Oil Sands Trust, would rise faster than those of companies producing prized (and pricey) light, sweet crude.
Schulich's goal was simple: "I bought this thing to make four times my money in three years."
(Incidentally, Schulich had a little skin in the game, too... He personally bought 3 million shares, separate from Newmont's position.)
Since then, the price of oil has doubled again, rising from about $53 a barrel to more than $107. And Canadian Oil Sands shares behaved exactly as Schulich predicted. While Canadian Oil Sands Trust's share price has "only" risen 171% since then, the shares split 5:1... That's a 384% total gain, counting dividends, in a little more than three years.
Here's why the Canadian Oil Sands investment was critical to Newmont. While the price of oil doubled, Newmont's mining costs rose along with it. The company spent $697 to mine an ounce of gold in 2007, up from $412 in 2004.
Newmont sold its gold last year at $700 an ounce, barely more than breakeven with its mining costs.
Meanwhile, Schulich's investment paid dividends in 2007 worth $8 per ounce of gold Newmont produced. While that doesn't look like much, it turned out to be the difference between producing gold at a profit or at a loss.
That's how bad costs have become lately. And oil isn't the only expense miners have to worry about... Fertilizer, believe it or not, has become a problem recently. Miners use a ton of nitrogen explosives to blast out the mines, but fertilizer costs have gone through the roof with the grain boom.
Steel and concrete, same thing. Two of the industry's biggest projects have seen construction costs escalate 30%-40%. But, as I said, the real issue is diesel...
Miners have to feed a fleet of trucks... everything from the water truck that keeps the dust down at the bottom of the mine to the huge three-story-tall ore haulers.
So investors have to remember that just because a company is producing gold, it doesn't necessarily mean it will make money.
These companies are exposed to the same high prices that we face at the pump... and the grocery store. Seymour Schulich helped keep Newmont afloat, but he wasn't quite able to overcome cost inflation.
While costs remain sky-high, I gold investors can consider skipping right to bullion or the Gold ETF (GLD) as opposed to buying big mining stocks.
Good investing,
Matt
