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Do Not Buy Yamana Gold Unless Gold Prices Rise Substantially

- By Alberto Abaterusso

Deliberations from the rate-setting committee of the U.S. Federal Reserve released on Feb. 20 suggest the policymakers don't yet know whether the pause on rate-tightening will be over sometime this year.

The situation is driving the price of gold up because when investors feel interest rates are going to stay unchanged for an extended period of time, the precious metal surpasses bonds and other fixed-income securities in their scale of preferred investments.

The effect on gold prices was apparent on the London Bullion Market and on the Comex. The bullion closed at $1,329.05 per troy ounce on the London market Friday, reflecting a 3.6% increase from the beginning of the year. Over the same period, gold futures climbed 3.9% to $1,332.80 per troy ounce.

Investors usually gain exposure to changes in commodity prices through investments in gold futures or directly in the commodity. They can also buy shares of gold producers that are traded on the stock market.

Some miners will benefit from the rising price of gold, while others will not. Among those stocks that are not a strong buy today is Yamana Gold Inc. (AUY).

The Canadian mid-tier miner targets 1,060,000 ounces of gold equivalent production for 2019, which is a 1.8% increase from 2018. The company guides production of 940,000 ounces of gold and 10 million to 10.4 million ounces of silver. Compared to 2018, gold production will be flat while the production of silver will represent a 27% increase. The volume of equivalent gold was based on a forecasted gold-to-silver ratio of 82.5:1.

Yamana Gold forecasts one ounce of gold will be exchanged with 82.5 ounces of silver in 2019 as gold will average $1,275 an ounce and silver will average $15.50 an ounce.

But if gold averages over $1,275 an ounce, a higher gold-to-silver ratio could result in a lower output of gold equivalent than is guided, which will impact the company's financials.

In addition, the miner expects operating costs to be higher in 2019. Therefore, avoid the stock unless gold prices rise enough to justify the price.

In 2018, when production totaled 1.04 million gold equivalent ounces, including 940,600 ounces of gold and 8.02 million ounces of silver, Yamana Gold's stock fell 11%, underperforming the VanEck Vectors Gold Miners (GDX) exchange-traded fund by 13%. The cumulative average price of gold was $1,268.49 an ounce and the cumulative average price of silver was $15.7058 an ounce. Thus, the gold-to-silver ratio was 80.7:1.

Diluted earnings per share improved 3 cents in 2018, but the company closed the year with a loss of 6 cents. The cash flow from operations declined 9.7% to $404 million.

As a result, I agree with those seven out of 14 analysts who recommend holding shares of Yamana Gold. The average target price is $3.48, reflecting a 33.3% increase from the closing share price on Friday of $2.68.

The stock has fallen 8% for the 52 weeks through Feb. 22 and is trading above the 200, 100 and 50-day simple moving average lines.

The closing price of $2.68 on Friday was 34% above the 52-week low of $2 and 20.5% below the 52-week high of $3.23.

The 14-day relative strength index is 53.64, suggesting the stock is neither overbought nor oversold.

In addition, regarding guidance costs for 2019, the company expects the total cost of sales to rise 2% to about $1,040 per gold equivalent ounce sold, cash costs to jump 6% to approximately $530 per ounce sold and all-in sustaining costs to increase 4% to $870 per ounce sold. Assumptions include credits from the sale of copper, which is a byproduct. In 2018, Yamana Gold produced 129 million pounds of copper. It is targeting 120 million pounds for 2019.

Disclosure: I have no positions in any securities mentioned in this article.

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This article first appeared on GuruFocus.