Gold has had a rough year. At $1,300/oz, even operational gold mines are threatened with closure. All-in cash costs for gold producers in 2012 averaged $1,211/oz. In other words, most gold gold mines are almost operating at a total loss. Meanwhile, the rest of the stock market is euphoric near all-time highs.
The Attraction
Still, many people want exposure to gold for general diversification. Most investors are not experts in commodities, but like most people, they know enough to want to allocate a small portion of their portfolio to gold. They also want to think for themselves, and do not want to invest in physical gold, suffering losses like $1,900/oz to $1,300/oz.
For investors approaching gold with fresh eyes and no existing investments, they can select anything they desire. The best place to look would seemingly be gold companies for exposure to the current bull market in equities, but as research will quickly reveal discovered, the major mining companies are falling like flies and there is nothing but carnage in the juniors.
Investors might continue their search. Royalty companies? Definitely not. Over the past year, Franco-Nevada (FNV) is down from $60 to $40 per share and Royal Gold (RGLD) has been sawed in half from $100 to $45 per share.
Gold Trusts? ETFs?
Not even close. All the underlying assets in trusts and ETFs have crashed alongside spot gold prices, and actively managed funds are performing even worse. SPDR Gold Trust (GLD), iShares Gold (IAU), Central Gold Trust (GTU), Sprott Physical Gold (PHYS), Central Fund of Canada (CEF) and all the countless others have been devastated over the past year.
Of course, the inverted ETFs are doing just fine...
Mining Equipment?
This is not exactly a sector with many options, and even the few stocks available have been falling: Caterpillar (CAT) $115 to $85 per share, Joy Global (JOY) $90 to $50 per share and Deere (DE) from $95 to $85 per share. Poor performance in this sector should be no surprise. Lower gold prices mean tightening the belt at all production facilities and delaying purchase orders for new equipment. To be fair, there have been a couple stocks that have done well in this sector, including Terex (TEX) and Tractor Supply (TSCO), but if commodity prices continue to languish, their share prices might also come under pressure. Regardless, this is a complicated sector with exposure to all commodities (not just gold), and equipment is just not a sector that interests most investors amid falling commodity prices.
So, what then? Not majors, not juniors, not royalties, not funds, not equipment. Is there any gold investment that might keep pace with the stock market's relentless rally?
Consider The Entire Gold Sector
Fundamentally, all majors carry popularity premiums in the form of multi-year revenue projections, bullish analyst coverage and constant media attention, so the best investors look elsewhere. Royalties, funds and equipment simply mirror the performance of gold, which has been performing terribly. No, investors want to put gold investment dollars where they can take some risk for some legitimate upside. Here are some qualities- a sort of wish list for gold investing.
- a stock, to participate in the incredible rally of the stock market
- not yet mining, to avoid popularity premiums
- commencing production by 2014, to avoid pies in the sky
- all-in costs below $900/oz (25% below the industry average)
- NI 43-101 report completed, to avoid other pies in the sky
Promised $900/oz Production Means Accepting Risk
Everyone knows that there are risks in the junior sector, but these risks are better than losing market capitalization simply due to waning popularity (reference the stock chart of any major gold company during the past year). A junior does not have revenues, a P/E ratio or any of the attributes that allow investors to traditionally value its business based on ongoing operations. Instead, a junior has property, mineral claims and a dream. It spends its entire life trying to prove to the world that its dream will become a reality by drilling test holes, pitching investors and paying mineralogical firms to verify its ability to mine. The end goal is always the same -- extracting gold out of the ground -- but very few of these dreams actually become reality.
Low-Cost Pre-Producers
Near term, low-cost pre-producers are nearing the finish line, and it is looking increasingly likely that their dreams will become the elite 1%. Because these companies have low correlation to the price of gold due to their huge discount to $1,400/oz gold, they exist in their own world. They swim under the radar yet rapidly approach maturity with cash flow, analyst reports, television appearances, newspaper articles and employee union negotiations. If they succeed, their share price should start an ascent that yields hundreds of percentage points within a year. If they fail to get final permits or catch themselves on any final snags, back to the cesspit of juniors they go. That is the risk:reward proposition, and investors can handle that.
With gold prices falling from $1,900/oz to $1,300/oz over the past two years, no one cares about juniors with projects 3-10 years away, and many are shelving their projects altogether. Likewise, optimistic valuations across the traditional gold sector (majors, juniors, royalties, funds, equipment) are crashing. The only worthwhile subsector of the gold market is near-term, low-cost pre-production.
A Few Worth Considering
- Midway Gold (MDW)
It estimates all-in gold production costs at $824/oz. From a technical standpoint, the stock has traded in a wide range, with its largest rally coinciding with peak gold prices in 2011. Its share price is roughly flat over the past year but has doubled in value from its range 3-5 years ago. This company is a straightforward candidate for investors to evaluate in terms of risk-to-reward.
- Pershing Gold (PGLC)
Pershing Gold purchased a mine out of bankruptcy that had produced over 100,000 ounces of gold. Its plan is to mine gold using existing processing facilities it owns, and it has already raised most of the capital it will need to start mining. It completed its NI 43-101 report on April 12, 2013.
Its property is adjacent to Coeur d'Alene's Rochester property and, located in Nevada, has easy highway and railway access, no geopolitical risks, skilled workers, and all the trimmings of U.S. production. It should be able to produce at $800/oz by early 2014. Its CEO previously built a company and sold it for C$186.9 million, and its insider trading ledger shows millions in open market purchases. Market capitalization stands at $100 million. From a technical standpoint, the stock has doubled from $0.30 to $0.60 within the past year and recently pulled back to $0.34, allowing an entry far below 52-week highs. Pershing Gold is a very cheap company with plenty of near-term catalysts that could provide nice returns for prudent investors.
- Premier Gold Mines Limited (PIRGF)
Premier Gold Mines CEO Ewan Downie founded Wolfden Resources and sold it in 2006 for C$346 million. Fidelity is an institutional stakeholder. Its Nevada and Geraldton properties will probably not enter production by 2014, but its joint venture with Goldcorp will. Its cost per ounce of gold will likely fall under $900 due to its financial partnership with Goldcorp.
Although investors might like the strength of this company's balance sheet, scheduling has them concerned. Only one of the company's three projects will be entering production by 2014, and that project is the smallest, 49%-owned joint venture. On the whole, Premier Gold Mines is a well-capitalized company, but it is about two years away from truly commencing its own mining operations. From a technical standpoint, the stock has traded as high as $8 per share during peak gold prices in 2011 and has retraced all the way to $1.81 per share. Nonetheless, it is still trading significantly higher than its lows during the 2008 financial crisis, and its large cash balance and analyst entourage makes it the most relatively expensive stock on this list.
Conclusion
Investors want to invest in gold. Most of them do not want to own the physical stuff, as anything with direct correlation has performed terribly over the past year (trusts, funds, ETFs, royalties, equipment and especially major miners). The only thing that makes sense to investors is near-term, low-cost pre-producers. Essentially, investors want to buy gold at a discount to today's $1,300/oz spot price, and they understand that that they must accept risk to achieve that discount. Before they invest in any company, they should complete due diligence and quantify that risk in comparison to the upside potential. To this end, this article has provided another way to look at gold investing and introduced some eligible investments to evaluate further. The next task is to start looking deeper into Midway Gold, Pershing Gold and Premier Gold Mines to evaluate company-specific risks