“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!

“Production for 2006 was 70,895 ounces of gold at an average cash cost of just $206 an ounce. In 2007, the company forecast its product would be more than DOUBLE its previous year’s, between 190,000 and 200,000 ounces of gold at a cost of $210 to $220 an ounce.
That’s why the company’s revenues SKYROCKETED, from $85 million in 2006 to $288 million in 2008. As for earnings, they went from $831,000 in 2006 to $164 million in 2008!

“That’s why this company’s stock recently TRIPLED in value in just six months. With its 2009 forecast of 100,000-plus ounces, and the development of another mine in China, this is a key holding! It’s an intermediate producer with a bright future.”

I sympathize with our fair editor here, I too sometimes fall in “love” with a stock — doesn’t usually work out that well, unfortunately, and I can’t say that I’ve ever been besotten with this particular firm, which is …

Eldorado Gold (EGO)

Now, we shouldn’t get that excited — after all, there were a lot of gold miners that nearly tripled investors returns over the last six months, if you assume that you bought at the severe V-shaped bottom in November and sold at the top in May. Not a lot of that going around, but if you did that, more power to you. The shares are just below $10, not far from the range they were trading in last Summer, before the bottom fell out of, well, everything.

And they do have a nice producing mine in Turkey, as teased, and another in China — they sold a Brazilian mine last year. They are aiming to become a pretty big producer within the next few years, with a goal of 800,000+ ounces a year by 2013, but this one might be a little rockier than some others — their two major mines have “mine life” of 9 and 13 years, respectively, which is on the short end compared to some big miners, so they may need to spend to increase reserves significantly. Of course, sometimes those mine life numbers are awfully pessimistic when companies hold back on booking reserves for those same mines, but it’s a possible concern. I don’t know Eldorado well, and I don’t have a reason to not be in “love” with them, just haven’t looked at them very closely before.

But this last one is the one that caught my eye — it’s sort of a venture capital firm for junior miners, and part of the reason I decided to write about this one today is that many folks have asked me in the past about ways to diversify in the junior mining sector — well, this is a possibility (not without a bit of hair on it, but a possibility nonetheless):

Opportunity #5:

“Take a Flier on a Junior Mining Operation That Could Take Off Like a Rocket!

“This stock is a great way to get in on the sky-high potential of the junior mining sector without having to take on the considerable risk of owning individual juniors.

“That’s because the company uses its management’s connections and know-how in the mining industry to get in on quality deals and quality mines.

“The basic business model is for this company is to acquire a significant interest in pre-IPO or early stage resource companies with underdeveloped or undervalued high quality resources. Then it provides advisory services with the goal of holding the interests for 18-24 months while maximizing valuations of these early stage investment properties.

“Among the juniors this company has a stake in are companies such as Auger Resources, Mama Metals, Virginia Uranium, U308 Corp., Kansai Mining Corp., Longford Energy, Central Sun Mining, Avon Resources, Tucano Resources, Kria Resources, Consolidated Thompson, Russo Forest Corp., Amazon Potash, Sulliden Exploration, Largo Resources, Apogee Minerals, Castillian Resources, and many more.

“I really like this company because it possesses a management team that has years of experience in the junior mining and has access to early stage financing on quality mining deals. Also, it is highly diversified. That means you don’t have to go out and hunt for the best juniors. The company does it for you. In addition, it has cash flow, possesses royalties, and trades at a large discount to net asset value.

“This is the type of speculative investment that gold bugs love. It’s a highly risky “penny” gold stock but the potential profits could be huge. In fact, I think it easily could QUADRUPLE in value from 20 cents a share to 80 cents.”

There’s actuallly at least one typo in there (there isn’t a gold miner called “Mama Resources,” they mean “Magma”), but this little investment company is …

Aberdeen International (AAB in Toronto, AABVF on the pink sheets)

Aberdeen is, in their words, “a publicly-traded global resource investment and merchant banking company focused on small cap companies in the Resource sector.”

And they do have portfolio positions in all of those companies teased — including equity, loans, and warrants. And it does trade at a huge discount to net asset value … though of course, these aren’t the kinds of “assets” that you could put on the market and reliably get a bid for on any given day, they are generally equity positions in very small exploration companies that are a long way from mining — and that, in many cases, may not ever become actual miners even if their commodity enjoys a long bull market. It’s a risky business.

But just like venture capital in biotech or any other business rife with startups, you count on a few huge winners to pay for the fact that the majority of the companies will never amount to anything. Most of them have assets beyond the intellectual property of their principals, of course, so perhaps it’s less risky than biotech or tech venture investing, but it is risky nonetheless.

So why the huge discount to net asset value? Well, most of the assets are worth a lot less, according to their fair value estimate, than they were a year ago — and it will take patience and skill (and perhaps luck) to extract that value, since most of these companies own rights or have done exploratory drilling, and in some cases even have real reserves booked, but don’t actually have any, um, what’s the word I’m looking for … money coming in. During times like last fall, that’s a disaster waiting to happen, because the value of those firms suddenly plummeted and the net asset value of Aberdeen’s portfolio pretty much got cut in half.

Aside from the general uncertainty of Aberdeen’s portfolio on any given day, it should be noted that they are very heavily exposed to one of their portfolio companies, Simmer and Jack, which owns the Buffels mine in South Africa. The company apparently defaulted on their loan from Aberdeen, so they’re exercising a right to a net smelter return (a royalty) that they apparently value at close to C$40 million, or nearly half of their net asset value. That may or may not be fair, but do be aware that despite the general benefit of a diversified portfolio of interests in 20 or so junior natural resource firms, there are times when they become very focused on one of those investments. They say that they’re trying to “Monetize” that royalty holding so that they can continue to focus on their portfolio companies — “monetize,” remember when people used to just say “sell?”

So there you have it — I’ve peeked at Aberdeen before and continue to think that it’s an interesting speculative firm if you’re interested in junior mining stock venture capital. Interestingly, their latest investment was in a firm, Dacha Capital, that’s fairly similar to themselves.

Patience and a continuing commodity bull market are perhaps the two keys to this one — and of course, there’s no way that a small investor can be reasonably expected to understand all of these little companies, many of which don’t have any public filings, so a bet on this is really a bet on Aberdeen’s ability to choose the right investments and strike the right deals. Additionally, you have to count on management to look out for shareholders interests and not just fatten themselves — top management did buy some shares personally this year, and do a stock buyback, so that’s a good indication that they’re on your side, if not a guarantee.

I wouldn’t bet on that “net asset value” gap closing anytime soon, given the huge uncertainty behind most of those assets, but this one does tempt as a speculative bet for tossing in the back of your portfolio and ignoring for a couple years.

And of course, if gold goes to $1,500 an ounce most of these picks will look brilliant — if it falls to $500, they’ll appear idiotic.

Enjoy your weekend, everyone!



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Mike McDonald
Mike McDonald
October 23, 2009 11:45 am

I have tried to send you $49.00 to become an irregular but you demand I have a PayPal account – you make it too difficult to send you $…..

B Polus
B Polus
October 23, 2009 11:48 am

IPO-Winter of 2009 = GDXJ??? Junior Mining Stocks in a bundle!