Gold Stocks
Gold and gold stocks have been a top performer over the last two years
as most other financial assets have performed in a dismal fashion. Current
equity valuations more resemble a market top than a market bottom. Gross
speculation still reigns. Things are very similar to early 2000, there are just
fewer players.
I believe this is not an isolated event, rather it is a sea change
after the gigantic bubble formed from
the excess liquidity that has been pumped into the US economy particularly
since 1995. The broad based monetary aggregates have increased at rates greater
than twice the growth in GDP. Government, corporate and household debt levels
are relatively extreme. Anecdotally, I
receive about five solicitations per week offering 0% money for one year will
no fees whatsoever. We have clearly reached a point where the old formula is no
longer working. The FED is near zero,
and a FED official was saying last week that even if FED funds go to zero they
can still buy bonds to inject cash and control long rates. They seem to believe
there is no situation which they cannot manipulate their way of out to a
positive outcome. They seem to be saying “reflate at any cost”. The only thing
keeping the dollar up is the fact that most central banks have the majority of
their “reserves” in US dollars. They need to have the dollar stay up, therefore
we can print all we want and continue to run gargantuan deficits without
consequence. What a predicament for all concerned.
The public has responded by investing heavily in the only appreciating
hard asset that they understand, real estate. This is very similar behavior to
that seen in the early 1930’s. Extreme some say? We are about to enter the most
protracted decline in corporate profits and stock prices since the Depression.
The WSJ had an article today about non-profit groups loaning the down payments
to very marginal home buyers and the non-profit being reimbursed by the home
sellers. This may be a sign of the end of the housing bubble. They are selling
three bedroom pre-fabs outside Reno, in the desert on an eighth acre for
$500,000.
The run up in gold and gold stocks has occurred with virtually no
involvement by the general public. A twenty year bear market and constant
brainwashing have prevented them from making money rather than losing it on all
the ridiculous stocks where even the “blue chips” are obviously manipulating
their earnings. IBM has less shareholder equity today than they had in 1995.
Once the public realizes that they can make money in gold then there could be a
run up even more vigorous than in the late seventies. Failing that, I see a
steady increase in gold prices over the next three to five years. When this
latest bear market rally tanks and real estate starts to tank, there will be
few places other than gold and commodities to go.
People scoffed at me two and
one half years ago when I said the NASDAQ could hit 1500 and also scoffed at
gold stocks doing anything, as many still do today. The ultimate bottom will be
found when CNBC shows golf all day. If we can print and borrow unlimited
amounts of money without destroying purchasing power, why not just give
everyone $1 million and get it over with.
That said, I have constructed a relatively conservative gold stock
portfolio as insurance in case I am correct in my projections once again. I
feel that any conservative investor should have 3-5% of his/her liquid
portfolio in gold and/or gold stocks.
If it all goes to zero, and all other investments staying static, you
would lose 3-5% of your portfolio. That might still beat some market averages.
If I am correct in my assessment, that 3-5% could save the day. Some may say
that you may be buying at the highs because gold is close to multi year highs.
I say that gold prices are historically low, and its intrinsic value is
probably in the area of $500 per ounce.
Finally, the Japanese have desperately tried to decrease the value of
the Yen recently. If the most troubled ( in a fiscal sense ) country in the
world is trying to keep its currency down, what does that say for the US
Dollar? A recent US Treasury report showed that the Japanese intervention in
the April-May period had no net effect after spending $33 billion US to depress
the Yen, arguably the worst currency of all. The CRB index is up over 20% in
the last twelve months. I have never been a “gold bug”, but I am now. I would
not touch general equities with a ten foot pole. Even if the numbers look good,
I don’t believe them. I was reading an earnings report yesterday that had a
headline number based on “Pre-marketing cash flow”. They are still at it.
All companies below have little or no exposure to hedging. Barrick,
Newmont, and Placer Dome, institutional favorites, have large hedge books. If
one believes in lower gold prices this may be good; but why would you buy gold
stocks if you are looking for lower price?. Sharply higher gold prices could
severely damage these producers. In 1999, two producers, Cambior and Ashanti,
nearly went bankrupt when prices spiked. South African producers have too much
political risk.
Goldcorp GG-NYSE
G-TSE Recent price $11
52 week: Hi: $12.35 Lo:$5.31
Average volume 1.4 million shares/day= excellent liquidity
F.D. Shares Out. 207
million $1.50/share cash and gold
Avg. total cost of production=$120/oz.
12 cent annual div.= 1.1% Yield
No L-T debt No hedging
Comment: Goldcorp is probably
the most conservative gold stock out there. Its production costs are the lowest
of any major producer. Reserves at year end 2002 will be equal to about ten
years production. The company more than replaced this year’s production with
new reserves. The dividend compares favorably to the current low interest rate environment. The Company should earn about 35 cents this
year. The Company would be profitable at $200/oz. gold, but the flip side is
that it is not that highly leveraged to gold price. Geopolitical risk is
minimal. A lack of diversification is a negative.
Hecla Mining HL-NYSE Recent Price:$4.10
52-week Hi: $5.90 Lo:$0.83
Avg. Volume 603,000 shares/day=
good liquidity
Shares out.: 86 Million
Avg. Production costs; Gold $200, Silver $4.00
2002 Production Estimate
235,000 oz. gold, 8.1 million ounces Silver
Debt levels minimal, minimal hedging
Comment: Hecla, always a significant silver producer has emphasized
gold production in recent years due to soft silver pricing. The production cost
of silver has steadily decline to the current $4/oz. area. Gold production
costs have also declined to a total cost around $200/oz. Company represents a
gold play for both gold and silver. Huge silver inventories have all but dried
up. Some project silver to markedly outperform gold. The Company only has about
4 years of gold production in reserves but exploration continues and they will
probably replace this year’s production with new reserves. Aggressive gold
exploration continues with good prospects of success. Silver reserves equal
about eight years of production. Highly dependent on mine in Venezuela for 75%
of gold production ( 25% Mexico). The majority of silver reserves are in the
US. Environmental concern in Idaho as agreement with US fell apart this year
and is being renegotiated. Company should break even this year will earnings of
20-25 cents/ share next year now that the balance sheet is straightened out and
production costs have been minimized.
Meridian Gold MDG-NYSE Recent Price: $15.75
52 week Hi: $20.88 Lo: $9.60
Avg. Volume 695,000 shares
/day= good liquidity
76 Million shares outstanding
Avg. Total Production cost : $110/oz.
Estimated 2002 Production: 435,000 oz.
No debt, little hedging
Comment: Company has very low cost of production. 2002 EPS in the 55
cent range. Current reserves equal about 7 years of production. Meridian is
diversified and completed recent acquisition. Also produces significant silver.
It has had good exploration results.
Kinross Gold KGC-ASE K-TSE
Recent price: $1.85
52 week Hi: $2.90 Low $0.62
Avg. volume: 1.25 million ASE 7
Million TSE=good liquidity
Shares out. 400 Million
Avg. Production Cost: $295/oz.
Estimated 2002 Production 925,000 oz.
Little debt, little hedging
Comment: Kinross is the sleeper. After completion of merger with TVX
and Echo Bay it will produce 2 million oz./year. Plans to reverse split and
relist on NYSE. Morgan Stanley says that this is the most leveraged gold play.
Higher risk, high return potential. Probably would appreciate 7X percentage
wise versus gold price. Every $25/oz. increase in gold price increases cash
flow 30%. Balance sheet is pretty clean after recent share sale ( incl. in
shrs. out ). At $500 gold, would probably trade near $15. This is the upside
kicker for a diversified portfolio.
I also like Glamis Gold, GLG-NYSE, but it seems fully priced on a
nearer term basis. Glamis has excellent long term production increase
potential, but again, seems to be priced in. Smaller producer picks include
Richmont Mines ( RIC-NYSE), High River Gold ( HRG-TSE), Arizona Star (AZS-TSE).
As a small high risk play I like Alamos Minerals ( AAS-CVE (TSE) ). The founder
Chester Millar, was the first to commercialize heap leaching in the 1970’s and
founded Glamis. They expect to produce at an annual rate of 20-40,000 ounces
next year at a total cost of about $210/oz.. If successful, the stock could
appreciate 10 fold even at current gold
prices.
Not an offer to buy or sell any security. There is no guarantee of
accuracy or completeness of the analysis of any company or industry. Tom
O’Brien and affiliates hold substantial positions in all stocks mentioned in
this analysis.