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how does fml stack up?Five Ms” For Picking Gold Stocks
An abridged excerpt from “The Goldwatcher: Demystifying Gold Investing,” co-authored by Frank Holmes, CEO and chief investment officer at U.S. Global Investors. The book, published by John Wiley & Sons, is available from amazon.com and in bookstores.

By Frank Holmes

Investors can improve their odds by learning how to assess the fundamentals of the gold exploration companies. A good tool for this job is what I call “The Five M’s.”

By using the Five M’s, an individual investor can build a simple but powerful model to initially sort through the many hundreds of upstart gold companies to find better opportunities.

1. MARKET CAP
If a junior gold company has 10 million shares outstanding at $1 per share, the company is valued at $10 million. The question any investor should ask is, “Is this company really worth $10 million?”

If the market pays $25 per ounce of gold in the ground, the company should be valued at $25 million. If the company’s market cap is only $10 million, it may look undervalued. If the company’s market cap is $50 million, it may appear to be overvalued.

For larger gold companies, an investor can measure a company’s market cap against its production level, reserve assets, geographic location and other metrics to establish relative valuation.

2. MANAGEMENT
Often the heads of junior companies are geologists or engineers who have no relationships in the brokerage business. This lack of relationships impedes their ability to generate market support.

Some of the most successful company builders in the gold-mining industry are what I call the “financial engineers”—people who have the relationships and understand the capital markets and who know how to hire the best geological and engineering teams. We tend to have more confidence investing in them.

3. MONEY
A gold exploration company has to deliver reserves per share to have a chance at another round of financing. It has to convince the capital markets that it is an attractive investment on a per-share basis.

The gold-equities market is efficient at judging reserves per share, so if the exploration company doesn’t come up with the results necessary to get an evaluation, investors quickly lose confidence.

There is an old rule when it comes to exploration companies: don’t pay more than two times cash per share if there are no proven assets in the ground.