Miners caught in bond rout as commodities extend slide

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The bond market rout is sending shock waves through the corporate credit market, but mining companies are taking a particularly hard beating as commodity prices tumble.

Corporate and government bond prices have fallen sharply since the Federal Reserve last week said it could pull back on its extraordinary bond buying program. Now commodity prices are extending their slide, creating an added level of anxiety among investors in bonds issued by some mining companies.

The price of gold plummeted about $45 to about $1,230 (U.S.) an ounce Wednesday, and earlier this week, the price of copper briefly broke through the important psychological barrier of $3 a pound. At these prices, some development projects are much less economic and miners make less money for each pound or ounce of metal they sell.

Falling bond prices in the mining sector are troublesome because many miners flocked to the bond market for refuge. Amidst massive cost overruns, multibillion-dollar writedowns and weakening commodity prices, many mining stocks fell more than 40 per cent in the past year, making it difficult for them to raise cash by selling new shares.

To fill the financing hole, miners raised $113-billion by selling new bonds in 2012, up from about $80-billion the year prior, according to Ernst & Young, and that trend had continued this year. Barrick Gold Corp. sold $3-billion worth of new debt in April and Goldcorp Inc. tapped investors for $1.5-billion in March.

But now the market is at a standstill as investors wait on the sidelines to see if the rout drags on. Both Barrick and Goldcorp's 10-year bonds issued earlier this are down roughly 12 per cent in just a few months.

With such uncertainty in the market, Susan Rimmer, managing director of debt capital markets at Canadian Imperial Bank of Commerce, said investors are now conducting some due diligence by reviewing the "price decks" put out by rating agencies, which estimate cash flows at different commodity prices.

Two months ago, Standard & Poor's lowered Barrick's long-term debt rating to BBB from BBB-plus, noting that with every $200 drop in the price of gold, Barrick's debt becomes a much higher multiple of its cash flow.

Barrick is in the spotlight because of its high debt load. After an ambitious multiyear strategy of major acquisitions and mining startups, the world's largest gold miner has accumulated more than $13-billion of debt.

Donald Marleau, a Toronto-based analyst with S&P, said Barrick had $1.80 of debt for every dollar of earnings before interest, taxes, depreciation and amortization when the rating agency downgraded the company, and another rating cut could come if this ratio rises to three times. At the moment, Barrick's ratio is 2.5 times, he said.

"The company's financial risk profile is moving close to a potential downgrade," Mr. Marleau said.

A spokesman for Barrick said the company continues "to look for opportunities to cut costs further" after a number of significant expense reductions and deferrals in the past year. He said the company's debt repayments will be "modest" over the next few years and the company has the added advantage of owning many of the world's lowest-cost gold mines. For example, 60 per cent of Barrick's production in the first quarter of 2013 came from five core mines that produced gold at a cost of $591 an ounce.

Although the current market is volatile, Ross Prokopy, managing director of debt capital markets at GMP Securities, said he believes miners with solid assets who operate in favourable jurisdictions and who demonstrate a very clear path to sustainable cash flow – meaning their development projects are close to completion – should be able to find investors.

Mr. Prokopy acknowledged government bond yields are rising, pushing up yields for riskier companies as well. He also acknowledged that the concurrent selloff in commodity prices certainly raises cash-flow risks. But he doesn't think it spells doom and gloom.

"Is there money to be put to work in the natural resources sector? Yes," he said. "It's just the money that we saw earlier in the year is going to be a little more tempered."