the case for gold miners

As we hear about job losses in bulk and base metal miners, losses in banking, retail etc..., and you look around where to put your money, it is hard to go past the gold sector. And in particular, gold miners (as opposed to a pure investment in the metal itself.

Here is why:

(1) GOLD IS NEAR RECORD HIGHS IN $A. Current around A$1,300oz. Not news to watchers of gold, I know, but this is clearly not reflected in the share prices of gold companies, especially outside of the top few well-known names. The increase in the A$ gold price does not affect profitability of miners in a linear fashion. Costs are (relatively) fixed, so the percentage increase in profit is larger than the increase in the gold price.

(2) INPUT COSTS ARE DOWN. As base and bulk commodities have fallen dramatically, almost all input costs have reduced, at least in real terms. OIL, HR, EQUIPMENT, ASSAYING. It is one thing to have an across-the-board mining boom, where all costs are under pressure. We have the situation currently where gold miners benefit both from HIGH PRICES AND REDUCED COSTS. A perfect storm.

(3) PRICES FOR GOLD COMPANIES ARE DOWN. With a couple of exceptions, many gold producers, far from being fully priced (reflecting their current profitability) are actually well down in price. De-leveraging institutions, margin calls, forced selling, and a general market malaise has dragged down gold miners, at the very time when their fundamentals are the strongest. So the value gap between the PRICE of gold miners (down), and the VALUE of gold miners (profits up) is huge.

(4) OUTLOOK FOR GOLD. Traditionally a safe-haven in times of economic and political uncertainty, many believe that the gold price itself will continue to rise. Many investors worldwide will look to gold as an alternative to paper currencies, especially the US$, who are not supported by good fundamental value.

At the same time, worldwide gold production is falling, especially in countries with low political risk, forcing miners to look for the yellow metal in increasingly inhospitable areas, in terms of both political risk, and low infrastructure. So even if the demand for gold in jewelry and industry reduces (and this factor is small in relation to the volume of gold that is hoarded), the supply is also dropping.

(5) A 'MARGIN OF SAFETY'. Buying gold itself is speculation in the purest sense of the word. Gold itself is not an income-producing asset. It can outperform other investments due to its increase in price, but it is a bet. It may go up, or down.

However, buying good gold producers at current price gives the investor a MARGIN OF SAFETY. This is because a fair valuation of many of these companies is much higher than current prices, EVEN IF THE GOLD PRICE DROPS. This is the crucial difference. Buy gold, and if it drops, so does your invesment. Buy an underpriced gold producer, and even in gold drops, they are still making robust margins, which support much higher prices.

If however, gold goes UP, these producers will profit even further.

So buying cheap gold producers at current prices is like a hedge which has a limited downside, but is still exposed to the upside. The upside is the price of gold, and a return to more reasonable valuations on current prices. And the downside risk on the price of gold is offset by the fact that the prices of the companies are already unreasonably low.


CASE STUDY - Troy Resources (TRY)

A classic example of the huge value gap is TRY. Troy is trading at just above its cash position of $60m. Current mcap is around $70m. It has an operating gold mine in Brazil, which is ramping up to 50,000ozpa at estimate life-of-mine costs of US$300oz. All capital items paid for, no debt, and unhedged in Brazil.

High gold prices have also allow Troy to recommence mining at Sandstone in WA this year, treating a planned 30,000oz of low grade ore, this time with hedging to protect the downside price risk. Another bonus of the high A$ gold price.

Troy also has a mill in storage, and other small JV's. And importantly in the current environment, Troy has the strategic advantage of CASH. Just when small miners are struggling to find capital, either through equity rasising or debt funding, Troy has the cash to pick and choose the most value accretive opportunities. And Troy also has a strong track record of both mine development, and investment (ie Comaplex).

Even in the last two quarters, when all once-off capital costs were being paid for, and lower grade ore was being processed, Troy was still cash-flow neutral. The only possible reason for the low price is that the market has not factored in the profits that will be made, as a backward-looking pe shows a loss last fy.

Managing Director purchase of $50,000 in the last few months. Quote:

"“At the moment equity prices are reflecting the fact that there are simply more sellers than buyers. Unfortunately some people are in the position where they are forced to liquidate their investments. Eventually however, share prices will reflect underlying valuations. Troy is trading below cash backing and with operating gold mines, no debt and no hedging, I am happy to put my money where my mouth is”


This is just one example of a 'perfect storm' of a buying opportunity (IMO). Record prices, reducing input costs, large cash backing just below the mcap, and a producing gold mine in a safe jurisdiction. MD on-market purchase. and trading at less than 1/3rd of its 12 month high.


Good luck, DYOR. I also like A1 Minerals (AAM), in the junior gold sector.