“Undervalued Gold Stocks Will Go Berserk”

By Travis Johnson, Stock Gumshoe, October 23, 2009

This article below was originally written for the Irregulars in their Friday File and published on June 23. It has not been updated or edited, but the ad is still circulating with similar, if not identical, language.

In regards to disclosure: Though I did own shares of Royal Gold, as noted below, at the time of first publication, I no longer own those shares. The sale was for personal portfolio reasons and I don’t have anything negative to say about the stock.

Most of these have had a nice run over the last several months with gold’s big recovery — but of course, so has every other reasonably decent gold miner.

I’ve never heard of David Skarica before, but I’ve been seeing a lot of ads for his stuff lately — he runs a newsletter called Gold Stock Adviser, and like so many others, he predicts that the bulge in US Government spending and borrowing makes inflation inevitable … and that the “gold rush is just getting started!”

That may or may not be true (remember, many people believe that real inflation of the money supply requires private lending as much as it requires government money-creation), but it’s certainly true that gold is a reasonable bulwark for any portfolio — and you can make a case for gold as a unique “bulwark” investment in any kind of environment, including deflation, due to its historical psychological primacy among us human beings as a “store of value.”

I’d hesitate to be nearly as aggressive about inflation (or gold) as those folks who are betting on hyperinflation with their entire portfolios, going short treasury bonds and long gold, energy and commodities … but I do have probably 25% of my portfolio in a combination of all of those things, with maybe half of that amount in gold and silver, and in the miners thereof.

But Skarica does tease a few specific investments for us, one or two of which I’ve written about before but most of which are new to these pages. So I thought I’d try to give the Irregulars the first crack at them today. He lists five “Gold Stock Opportunity” investments, let’s have a gander.

The first one he actually names — Agnico-Eagle, which trades at a nice premium price today in part because it had great timing, they ramped up production and became a big miner just as the gold rally really caught a head of steam, so there are a lot of folks who love this one.

And the second one is more or less a “gimme,” too — he teases that he has a favorite gold exchange traded fund, but it’s one that holds a basket of miners, not the bullion. If that’s not the Van Eck Market Vectors Gold Miners ETF (GDX), it’s something else that’s going to pretty much exactly track with GDX. GDX actually has 31 components currently, but it certainly holds all the ones most investors have heard of, like Kinross, Agnico-Eagle, Goldfields, Yamana, etc. And it’s got fine volume and a lot of interested traders, so if you think “gold is going up, so miners will profit” but also think “what the hell do I know about choosing the right gold miner?” … well, GDX is probably the safest bet for a basket of the big miners. It’s market-weighted, so though it holds a bunch of little guys, too, they’re not going to move the needle very much.

But then the teasing gets into full force — Gold Stock Opportunity #3 is teased thus:

“Invest in a Company That Collects Royalties In Many Different Gold Mining Concerns

“Another way to invest in gold-mining stocks is to pick a company that follows the royalty model. In the royalty model, a company invests cash in other gold companies or gold properties — and then gets an interest in that property for the one-time payment.
The advantage to this approach is that it limits capital expenditures. Mining is very capital intensive. You must buy machinery, pay workers, and pay for gasoline, electricity, sometimes even leasing fees on properties, and so on.

“But a royalty company avoids all that. Its only expenditure is the investment its makes in the various mining properties.

“That is what this third gold stock I recommend has done. Its three operating partners are Alamos Gold, Newmont Mining, and Barrick Gold — three solid, well-run mining companies. They also are developing numerous royalty investments that should go into production in the coming years. In all, the company I recommend has a stake in no less than 14 producing properties, which also diversifies the company against any mishaps at any one property, and five other properties in development.

“The business model has worked out very well. Revenues have more than TRIPLED in just four years, from just over $21 million in 2004 to $69 million n 2008. The only reason earnings dipped in 2008 was because of big increases in amortization and depletion expenses. Free cash flow also increased in the same period, to $15.5 million in 2008 from $5.8 million in 2004.

“Inflationary pressures in the 2004 to 2008 period increased gold production costs by about 80%. But, fortunately, this company doesn’t have to pay any of those costs; instead, it just collects royalties off its investments in producing properties. That’s one reason this gold stock even pays a small dividend, which not many gold companies can claim.”

Well, you may already know this one — and you might know that I’m a bit predisposed to like it, since I own shares. This is clearly Royal Gold (RGLD), the only large(ish) publicly traded royalty company that’s really focused entirely on gold (except for a few legacy holdings). RGLD did have revenues of $69 million last year, and revenues and earnings have been climbing nicely as gold has done so well and some of their royalties have picked up production levels — they didn’t actually see a dip in earnings last year, they saw a dip in earnings per share because they increased the share count by about 25%. They do pay a little dividend, and they’re not cheap, but I continue to think this is a good way to get a diversified basket of royalties on gold, with some explosive potential if gold really climbs dramatically, and with less of a threat to their operations if operating expenses climb dramatically (ie, with another oil spike).

Moving on — opportunity number 4:

“A Gold Stock That Nearly TRIPLED Investors’ Money in the Past Six Months!

“Man, I LOVE this stock! This mid-tier mining company owns a 100% strake in a Turkish mine located between the major centers of Izmir and Ankara.

“Early exploration at this mine occurred from 1996-2002. In early 2002, after 10,700 meters of drilling, a drilling company updated the measured and indicated categories to 166.4 million tonnes @ 1.13g/t.

“That works out to 6.05 million ounces!

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“A 2005 capital cost update to a 2004 feasibility study indicated that proven and probable reserves were calculated at 135 million tons.

Translation: This company has A LOT of gold!