It only took
eleven years, but in 2011 global gold-mine production has finally returned to
pre-bull levels. In fact, with
2011’s volume expected to come in at around 88m ounces, we’ll see
a new all-time production
high. The latest
exploration-and-development cycle is finally starting to bear fruit!
This fruit has
been hard-earned though, as the miners have had to reverse the course of a
brutal production decline
that bottomed out in 2008.
Incredibly global gold production had fallen nearly 13% in five years
from 2003’s high, to a level not seen since the mid-1990s. And needless to say that painted quite
an alarming fundamental picture considering demand was on the rise.
Thankfully in
the last three years the miners have diligently worked to grow production,
adding about 15m ounces per year to supply at 2011’s rate. And we’ve seen this production
growth on a variety of different fronts.
The miners have brought back to life past-producing mines that now
have positive economics at the current gold price, they’ve expanded
existing mines to push through more material, and they’ve built
brand-new mines to tap the latest generation of discoveries.
This growth is
the product of billions of dollars of capital investment, along with a
healthy dose of blood, sweat, and tears.
Gold mining is a tough business, especially in a world where gold is
getting harder and harder to find.
And the miners in the trenches getting their hands dirty to bring us
the shiny-yellow metal we so crave must be rewarded for their endeavors.
This reward
comes in two main forms, profits and stock appreciation. If a miner can sell its gold for more
than what it costs to produce it, it should make a profit. And operating profitably obviously
goes a long way towards its stock price heading higher. As investors, both profits and stock
appreciation capture our attention.
And with now hundreds of gold-producer stocks to choose from, we have
a myriad of options.
One way to
break down these options, at a high level, is to figure out where the miners
fall in the global supply chain.
By categorizing the miners into like peer groups, investors have a
mechanism for identifying outperformers and underperformers, while also
gauging risk.
First and
foremost are the majors, which naturally own the largest piece of the
production pie by far. And
thankfully many of these miners have NYSE listings, giving investors easy
access to their liquid stocks. As
a group most of the world’s biggest and best gold-mining stocks reside
within the venerable NYSE Arca Gold BUGS Index
(HUI).
The HUI is
comprised of 16 stocks (most of which are dual-listed on the Toronto Stock
Exchange), including the world’s six largest gold miners (Barrick Gold, Newmont Mining, AngloGold Ashanti, Gold
Fields, Goldcorp, and Kinross Gold).
This index is rounded out by several other top major and intermediate
producers. And with combined
production of around 33m ounces, it is the bellwether vehicle that investors
look to for strategic movements in the gold-stock sector.
But though the
HUI components combine to account for about 38% of gold’s total mined
supply, 50m+ ounces per year of production coming from outside this camp
naturally allows for many more investment options. Interestingly though, most investors
aren’t familiar with where the rest of these ounces come from.
Even though the
US and Canada tend to be the hubs for natural-resources stocks, particularly
gold stocks, not all companies list on their big-board exchanges. Companies like Newcrest Mining (world
#7, ~2.5m ounces) and Polyus Gold (world #10, ~1.5m
ounces) have their respective primary listings in Australia and London for
example. US investors can buy
these stocks via the Pink Sheets, but that realm is only for experienced
traders.
Another big
chunk of this 50m+ ounces are from mining companies that produce gold as a
byproduct, with Freeport-McMoRan being the best example. Even though FCX produces about 1.6m
ounces of gold per year (ranking it in the top 10), it is better known as the
world’s largest publicly-traded copper miner. FCX’s gold only accounts for
about a fifth of its total revenue.
There are many other mining companies like FCX that do produce gold,
but as a subservient mineral to say copper, zinc, or silver. These companies’ stocks are not what investors should own if they
are looking for gold exposure.
Also part of
non-HUI gold production is the 11m or so ounces produced in China, and the
nearly 3m ounces produced in Uzbekistan.
And unfortunately most of these ounces are inaccessible to US
investors. As for China, while
there are some exchange-listed companies (Zijin
Mining Group listed on the Hong Kong Stock Exchange is the largest), the
majority of its gold is produced by smaller miners that are either
government-owned, don’t have a stock listing, or are illegal. And since most of the gold production
in this country is consumed domestically, there isn’t much motivation
to formalize China’s gold-mining industry.
In Uzbekistan
most of its gold comes from the massive Muruntau
mine, the largest open-pit primary gold mine in the world (~1.8m
ounces). Interestingly Newmont
was in this country for a while, producing gold from Muruntau’s
tailings, but its assets were illegally expropriated. Muruntau,
another massive gold mine under development, and the rest of the Uzbek gold
mines are operated by state-owned companies. And this precludes any type of foreign
investment.
Moving down the
rungs are the world’s intermediate, or mid-tier, gold miners. And thankfully investors have dozens
of options with their stocks. In
the US and Canadian markets investors have access to such companies as AuRico Gold (~470k ounces), Alacer
Gold (~440k ounces), and Osisko Mining (~640k
ounces). And in the foreign
markets Petropavlovsk (~680k ounces) and St Barbara (~350k ounces) are among
the better known.
I categorize
this mid-tier group as those miners that produce between 200k and 800k ounces
of gold per year. From a risk
perspective these mid-tiers are naturally going to be a bit more risky than
the majors. They usually
don’t have the operational diversification and financial strength of
the majors. And because of their
smaller size, they tend to hold more downside risk when gold stocks fall out
of favor. But their smaller size
does have its benefits. The mid-tiers
are always acquisition targets, and they can move to the upside a lot faster
when capital chases gold stocks.
Rounding out
the mined supply of gold are those ounces attributable to the juniors. Junior producers are gold companies
that produce less than 200k ounces per year. And it is in this realm where
investors will find the most abundant population of stocks. In my recent survey of junior
producers, I tallied nearly 100 that list in the US and Canada alone. And it is these stocks that offer
investors the biggest risk/reward trade-off.
Even though the
output of any individual junior is miniscule in the grand scheme of things,
in aggregate this group is very important in the global supply chain. In 2011 these miners produced a
combined 5.5m+ ounces, which is very material. But even more important than this
volume is their role in the gold-mining ecosystem.
Provocatively
most juniors either didn’t exist or weren’t producing gold a
decade ago when this bull was just getting started. Capital from retail investors, their
primary source of funding, was essentially non-existent. Gold mining was not sexy, and there
wasn’t much money to be made with where gold’s price was at.
But as gold
gained popularity, and appreciated in price, the market for these juniors
quickly opened up. Investors
craved the rapid gains that could be won with these stocks, and the larger
producers were desperate to replace their reserves and bolster their
portfolios (most of which were quite neglected amidst gold’s secular
bear).
The
entrepreneurial geologists that formed these juniors were among the first to
take the risk of exploring for gold in this new bull. They risked their capital and their
livelihoods scouring the world for the next generation of gold deposits. And over the last decade they’ve
been invaluable contributors to the supply chain.
Juniors’
contributions have been both seen and unseen over the course of this
bull. Seen are the juniors
operating their own mines today.
And unseen are those countless many that have been acquired. It’s no secret that many of the
new mines that the mid-tiers and majors are bringing online were originally
discovered and/or developed by the juniors.
So as
investors, how are we to look at juniors? Most important is we need to accept
the juniors for what they are in the world of gold stocks, risky. When you look at the profiles of these
companies, you’ll first notice that most operate only a single
mine. This obviously gives them a
higher level of risk due to the lack of diversification.
Junior
producers also have financial risk, with their balance sheets and cash flows
nowhere near as strong as the mid-tiers and majors. As for their balance sheets, the good
news is most juniors don’t have much debt since they raised most of
their capital via equity financings.
But you’ll also find that most are cash-strapped, with very
little working capital. They are either
recovering from the big draws of a recent mine build, or are in the process
of aggressive exploration and/or development programs in their quests to
find/build their next gold mines.
Their balance
sheets also tend to be weak due to a lack of cash-building income. Even though these juniors are now
generating revenue, cash flow is not yet material enough to quickly build
back up the treasury. With
average annual production of only 79k ounces, the juniors aren’t
exactly drowning in cash. Margins
also tend not to be as good in this realm, as juniors’ costs are on
average higher than those of their larger counterparts. As part of my research I carefully
examined cash operating costs.
And as you see in the chart below, this difference is quite
substantial.
In 2011 the
average cash operating costs for juniors was $723 per ounce, compared to $574
per ounce for the larger miners that comprise the HUI. On average it costs 26% more for the juniors to produce
their gold than the majors. This
difference is indeed considerable, and I’ve found there to be a number
of reasons for such a spread.
First and
foremost it is imperative to understand that mining costs in general, for all
miners, have been sharply rising in recent years. Amazingly back in 2006 average cash costs for
the world’s major gold miners was only $250. A double in only five years seems
excessive, but in reality things aren’t as mismanaged as
perceived. Some of this rise is
naturally attributable to rising materials, labor, and energy costs, but much
of it has to do with the quality of the ore sent through the mills.
With the price
of gold on the rise, miners have had the luxury of intentionally
“low-grading” existing operations (saving the higher-grade
material for lower gold prices).
They’ve also been building new mines on deposits that are either
low-enough grade or have complex-enough geology where the economics are only
feasible at higher prices, and juniors in particular fall into this
camp. Ultimately squeezing an
ounce of gold out of the earth from lower-quality/higher-complexity ore is
going to be more costly.
Expanding on
the ore-quality issue, junior producers often have a tougher time planning
and controlling their grades.
Prior to development many either don’t go through the effort
(advanced drilling and metallurgical testing) necessary to understand their
deposits, or don’t have the money to pay for feasibility studies that
would prove up their resources.
When the planning/engineering/design isn’t thorough, operations
are likely to struggle. And when
the grade control isn’t optimized, costs are going to be higher.
Overall
juniors’ operational and financial risk definitely makes their stocks
more speculative than the larger gold stocks. But don’t let their challenges
dissuade you from dabbling in this realm. The rewards for owning the right
junior producers, at the right time, can be legendary.
Remember that
these juniors are producing gold in a gold bull. And even if this gold is being
produced at a higher average cost, there is still plenty of margin to be had. Even at these higher costs,
2011’s margins were some of the best ever seen. With 2011’s average gold price
of $1573, the majors and juniors scored respective gross per-ounce cash
margins of $999 and $850. This is vastly better than 2006, where
an average gold price of $604 yielded margins of only $350.
And if the
margin differential between the majors and juniors makes you think twice
about investing in these smaller producers, keep in mind that it takes a lot more capital to push a
high-market-cap stock higher than it does a smaller-market-cap stock. When gold stocks gain popularity, it
doesn’t take much capital chasing the juniors for their stocks to soar
higher.
It is also
important to consider the attractiveness of juniors as growth stories and
acquisition targets. Quality
juniors won’t remain juniors for long. They’ll either grow organically
or via mergers and acquisitions, or they’ll be snatched up by the
larger mining companies. And the
majors are now really starting to swing around their capital considering gold
stocks’ general undervaluation
after being out of favor for so long.
Most important
for investors considering juniors is effective due diligence. The cash-cost average in the chart
above is just that, an average.
Several juniors are producing their gold at costs over $1000, and
several are producing at costs under $500. Some juniors are losing money, are
poorly managed, and have low-quality assets. Meanwhile others are making money hand
over fist, have top-shelf management teams, and own spectacular portfolios of
assets.
As a product of
our latest round of research focused on junior gold producers, we distilled
the universe down to our favorite dozen that are profiled in our new report. We
believe these stocks to be the elite in their group, well-run gold miners
with exceptional assets. Included
in this group are juniors that have recently commissioned brand-new mines,
those that are working to develop a second or third mine, and several that
fall into this category only as a temporary layover on their way to becoming
mid-tier producers. And to
demonstrate their quality relative to their peers, their average 2011 cash
costs were only $493.
At Zeal we do
this research not only to educate ourselves on a given sector, but also to
feed trades to our acclaimed weekly and monthly
newsletters. So far we’ve
recommended six junior-gold-producer-stock trades from our new report in our
newsletters, and as of this week the average unrealized gains of these stocks
is +32%. Not bad for positions that have been
outstanding for less than two months! Subscribe today to
see which stocks we are trading, and also to gain invaluable market wisdom
and knowledge via our cutting-edge analysis. And if you want the detailed
fundamental profiles of all 12 of our favorite junior gold producers at your
fingertips, buy your report today.
The bottom line
is when the dust settles on 2011, the gold market will likely have seen
all-time record supply from mine production. The miners have finally taken heed to
the call of this gold bull, and as a result stock investors have seen their
options greatly expand over the years.
The reliable
major producers continue marching along, pumping out a large chunk of the
global supply. The mid-tier group
remains strong, its population flowing and ebbing as graduating juniors
replace those leaving due to M&A.
But the most dynamic group of all is the juniors. Juniors have been paramount to the
growth of this industry, and they continue to pioneer the exploration and
development of the next generation of gold mines. Fortunately for investors
junior-producer stocks are plentiful, and the quality ones have the potential
to deliver huge gains.
Scott Wright
Our expert research team looked at the universe of 100 or so junior
producers trading in the US and Canada, and after thorough analysis whittled
this group down to our dozen fundamental favorites that we believe have the
highest probability for success. Each of these stocks is profiled in detail
in our hot-off-the-presses 34-page research report that is now available for purchase on our website. Buy your copy today!
At Zeal we use reports like this to feed trades in our acclaimed weekly and monthly newsletters. And we recently issued new buy
recommendations on several of our favorite junior gold producers. We
anticipate that these stocks will see gains akin to the 51%+ average
annualized realized gains that we’ve had in nearly 600 stock trades
recommended in our newsletters since 2001, and hopefully better. Subscribe today to see our current trades and get truly contrarian
stock-market analysis.
The bottom line is even though gold continues to forge higher, gold
stocks have disconnected from the historically positive leverage that
investors are used to seeing. Not only have the gold stocks not kept pace
with gold, they’ve sold off hard, with the juniors just getting
brutalized.
But so long as gold’s bull remains intact and its fundamentals
compelling, this gold-stock fear will prove totally unjustified. The most
ardent of contrarians realize that gold stocks can’t be held down for
long, and that the carnage we’ve seen, especially in the juniors,
offers huge buying opportunities. Selling has likely reached the point of
exhaustion, so carpe diem before the herd returns.
So how can you profit from this information? We publish an
acclaimed monthly newsletter, Zeal Intelligence, that details exactly what we are doing in terms
of actual stock and options trading based on all the lessons we have learned
in our market research as well as provides in-depth market analysis and
commentary. Please consider joining us each month at … www.zealllc.com/subscribe.htm
Thoughts, comments, or flames? Fire away at scottq@zealllc.com . Depending on the volume of feedback I may
not have time to respond personally, but I will read all messages.
Thanks! Copyright 2000 - 2005
Zeal Research (www.ZealLLC.com)
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