Sunday, January 28, 2007

Live Quotes on Blogs

Yahoo is offering live quotes on blogs. I've decided to try this on here.

There are three options on which live quote to choose, and of course the quotes are delayed by 20 minutes. The sample I've attached is the most detailed and the largest setting.

This service is currently only available for NYSE, NASDAQ and AMEX.

The link to add your own is

Have fun.

Read More......

Saturday, January 27, 2007

Saving for Retirement

The article copied at the bottom caught my attention.

I've questioned the economic advice of those that have pumped retirement savings at peril of debt repayment and lifestyle much of my adult life.

Housing: A big priority.

My view is somewhat different in that I have always considered that the first priority was to secure a home, so that when you retire you no longer have mortgage or rent costs, and once you've secured your home, you put the money you would have paid towards the mortgage to retirement savings, and once you retire, your income needs decline by the rate of savings, and the costs of going to a job. They increase by the cost of what you do to fill all that extra time.

Currently with the high cost of housing, I do not think entering the housing market is a good idea, but certainly saving for a better entry point is still a wise money management decision.

If you are not living the lifestyle you would like to live in your retirement, then you will need to save more.

I have also always looked at down sizing the home as a part of retirement planning. In Canada there simply isn't any capital gains taxes for your home.

So, my retirement plan has included buying double the home I need and RRSPs. It holds protection against currency devaluation. I down size at around retirement and I have a nice nest egg to live off. When it comes time to look for some kind of support living arrangement, I sell off the rest of my home and that finances that extra cost.

As the home is the biggest investment, it is extremely important to pick a good entry point into the market. When it seems like housing prices are going up, and up and up and if you don't get in now you will never get it, well, that is the worst time to buy. A decision to buy in these conditions will compromise lifestyle and ability to save for retirement for life. Choose to buy in these conditions is choosing to ensure that your economic future is much harder than it needs to be.

I know the economy where I live, and from 1986 to 1992/3 we had a bull run on our housing market. People that got in around 1986 to 1988 won the quarter million dollar, or better, housing lottery. Their economic future was secured by triple or quadrupile, or even more, increases in the price of homes. Add in the leverage that a down payment could have been as low as 10%, well, that is as much as a 5000% return on investment. People that got in around 1989-1990 have done ok, they also secured homes that appreciated far in excess of what they paid, and are better off for buying when they did, and still had lifestyle preserved.

Those that bought in 1991-1995 paid peak prices and many saw their homes worth less than they paid for them, or relatively flat in valuation for the next 5-8 years. Mortgage payments were such that it ate up the ability to save or have lifestyle, and wage increases have been poor through that time line as well, so there has also not been the increase in income to provide more disposible income. My home was selling for 10% less in 1998 then it was in 1995. I know many people who sold homes they bought in the 1993-1996 years for less than they paid for them in the 1996-1999 years.

Prices were relatively flat and in some cases declining until about 1996-1998. Somewhere around here was again good entry years. From 1998 to around 2000 were very good entry years again and 2001-2003 have also been reasonable entry years. Prices are up from 2004, but prices were also grossly crippling to lifesyle, and they may decline back to 2004 levels.

So, with respect to housing, the market is high, be patient, save your money, and if you plan to enter or upgrade, look to do it around 2010-2014. It is probably still a good time to downsize. Check out the housing market prices and trends in your area over the past 30 years and look at that and take it into serious consideration about when to buy. In general, about 4-7 years after a peak is a better time to buy. An investment into a home is so enormous, it is worth doing this kind of analysis, and to be patient.

Savings: How much to save and when depends on interest rates.

When I got into the housing market interest rates were around 10% for 5 year mortgages. In Canada mortgage rates are renewed at the end of a choosen term, which can be as short as 6 months. Five years is considered a long term. I saw many lose their homes when interest rates increase dramatically in the early 80s. New homeowners lack equity in their homes and it is wise for them to secure longer term financing, even if they end up paying more. It is especially wise with today's low interest rates as if you consider the past, interest rates have been as high as 20% or more.

The low interest rates do suggest that there is opportunity to gain a better rate of return on savings with careful investment. All investments that earn a better rate of return than a mortgage have downside risk, so it is very risky for a new home owner without much equity in their home. Paying down mortgage guarantees a rate of return equal to the mortgage rate. After taxes, investments need to bring in at least double the mortgage rate to be worth the risk. I believe it is better to wait and pay down the mortgage until you can afford your mortgage should interest rates again increase to the 10% range. But then, I have the experience of seeing many people lose their homes because of increasing interest rates and I am cautious that way.

How much do you need?

This entirely depends on pension income. If you have a pension worth 60+% of working income, that along with government pension, extra tax breaks and savings from work related expenses means that income level will remain relatively constant going into retirement without any savings, or downsizing.

Those without a work-place pension need to provide about 50-60% of their working income to maintain lifestyle. Saving for retirement stops at retirement, as do work related expenses.

Down sizing can give a good boost to retirement income. Every $100,000 dollars in savings can provide about $6,000 of income per year, using 6% per year. Say you want $50-60,000 per year from retirement savings, well, that's $800,000-1,000,000 in retirement savings.

This, with government pension, taking off 10% for savings, would give you a lifestyle comparable to if you earned $75,000 per year while working.

I put these numbers into a financial planner on

The results were that if I made $75,000 now, and had about that in savings, I would have to save $29,000 per year to have about $1.9 million for retirement. Notice that I'd be living on $46,000 per year if I saved at that rate? Obviously, along with my government pension, my lifestyle would more than double at retirement following their advice, and like the article below suggested, I'd have no lifestyle.

What do I calculate?

Assume the starting point is age 45, retirement savings so far is $75,000, you invest wisely and earn 10% return, and you can afford $7,500 savings per year, and you save in a tax sheltered RRSP. At age 65 you would have $934,000.

This example does not take into account inflation. With 20 years of 2% inflation, you'd need about 1.25 million for an income of about $75,000 per year, rather than $50,000. To compensate for inflation you'd have to save about $11,000 per year and increase savings by 2% per year.

But neither of these examples uses any home equity. With inflation, down sizing would provide for increased income needs due to inflation.

So, I calculate saving at a rate of $7,500 per year for 30 years and investing wisely would provide enough for someone without a pension. But you do have to be proactive about investments to make 10% per year.

A Contrarian View: Save Less, Retire With Enough

Could it be possible that you are saving too much for your retirement?

Such an idea would fly in the face of almost every exhortation to a nation of spendthrifts that saving more is an imperative. After all, even as people are living longer, corporate pension plans and Social Security can no longer be relied on to ease most Americans through their retirement years. Fidelity, the nation’s largest provider of workplace retirement savings plans, says the average 401(k) account balance is only $62,000.

Beyond that, the national savings rate — the difference between after-tax income and expenditures — is actually negative, government statistics show.

Nevertheless, a small band of economists from universities, research institutions and the government are clearly expressing the blasphemy that many Americans could be saving less than they are being told to by the financial services industry — and spending more — while they are younger. The negative savings rate, they say, is wildly distorted.

According to them, the financial industry, with its ostensibly objective online calculators, overstates how much money someone will need in retirement. Some, in fact, contend that financial firms have a pointed interest in persuading people to save much more than they need because the companies earn fees on managing that money.

The more realistic amount could be as little as half the typical recommendation made by Fidelity, Vanguard or any number of other financial institutions.

For a middle-income couple, that could mean trading $400,000 in retirement money for about $3,000 a year more during prime working years to spend on education or home improvement. “For a middle-class household, that’s a lot of money,” said Laurence J. Kotlikoff, a Boston University economics professor, who is on the forefront of this research into spending and savings, and is selling his own retirement calculator.

Andrew Behla is a case in point of someone who is not saving enough. Mr. Behla, a Los Angeles graphic designer and consultant, is at age 38 just starting to think about retirement. He and his wife, Michele Krolik, a payroll manager, together have just $70,000 squirreled away for their old age.

“I think we will have to save a lot more,” he said, a point on which the economists and the financial planning industry would agree. Even so, the couple recently bought a house and put extra money they had into improving it, figuring that over their lifetimes it will add handily to their net worth.

But other people like Beverly Alexander, 49, an energy consultant in Marin County, Calif., might be able to slow down. Her financial planner has her retirement finances mapped out to age 105 (her parents are still alive in their 90s), a plan that gives Ms. Alexander, a former utility executive, the freedom to quit her corporate job and live on her consulting income.

“One reason I could retire,” she said, “was that I saved and I always lived below my means.”

The findings of the economists are being met as most challenges to orthodoxy are: with stony silence or extreme umbrage.

“I count myself as deeply skeptical,” said Christopher Jones, the chief investment officer at Financial Engines, a financial planning software company.

The big financial services companies refused to comment on the research but they did say that their use of simple rules of thumb keeps the process of retirement planning less complicated, and thus, less daunting.

John Rother, policy director with AARP, says the economists are “not doing anyone a service because of the tremendous amount of effort it takes to get people to save.”

Nevertheless, the loose confederation of well-regarded economists, who have not been working in concert, say their research points to the startling conclusion that many Americans are saving too much, not too little. Indeed, their studies of the savings and spending habits of the generation born between 1931 and 1941 revealed that at least 80 percent had accumulated more than enough wealth for retirement. While they have not studied the baby boom generation as closely, they believe that the greater wealth of that generation should also leave those retirees secure.

A study last October by another group of economists, including two working for the Federal Reserve Board, found 88 percent of retirees age 51 and older had adequate wealth.

“Even the most casual reading of the popular press will have you convinced that Americans are heading like lemmings over a cliff,” said John Karl Scholz, an economics professor at the University of Wisconsin at Madison. “Going into this, I had no idea that we’d find any results anything like this.”

The argument between the sides is similar to the classic debate between the hardworking ants and lazy grasshoppers of Aesop’s fable. The financial planning industry says saving, even too much, provides a safety net and peace of mind, and possibly a gift to heirs at the end.

The economists answer that people would get more out of their money by using it when they are younger. “There is risk in saving too much,” Mr. Kotlikoff said. “You could end up squandering your youth rather than your money.”

Mr. Scholz said he and his co-authors of a study, “Are Americans Saving ‘Optimally’ for Retirement?” found oversaving across all economic and education levels and most ethnic or racial groups as well. (It found that Hispanics tended to save less.) Those who were not saving enough were usually missing their target by only a small amount.

The one exception to this optimism involves people who enter retirement single, either because their spouse died early, they divorced, or they never married. The studies found this group did not save enough.

“If they are worried about end-of-life medical expenses or they don’t mind leaving money to their heirs,” Mr. Scholz said, “then oversaving is fine.” The dispute revolves around how financial planners determine how much a person should save. That amount will vary depending on age, income and assets. To simplify the calculations, computer programs resort to rules of thumb.

The starting point for most retirement plans is the so-called replacement rate. It says an American needs an annual income in retirement equal to 75 percent to 86 percent of what he or she earned in the final year of employment. Someone making $100,000 would typically plan for about $85,000 a year in retirement.

Coupling that with a second industry rule of thumb that says retirees should spend no more than about 4 percent of their assets each year to make them last, a typical couple with that level of income should enter retirement with at least $2.1 million in assets, including 401(k)s, I.R.A.’s, stocks and bonds, real estate, cash value life insurance, pensions and Social Security benefits.

Not so, says Mr. Kotlikoff. It may be simple, but he argues it is more important to look at how people spend their income while working to determine how much they will need when retired.

Mr. Kotlikoff’s calculations showed that Fidelity’s online calculators typically set the target of assets needed to cover spending in retirement 36.4 percent too high. Vanguard’s was 53.1 percent too high. A calculator offered by TIAA-CREF, one of the largest managers of retirement savings, was 78 higher than his calculation.

Fidelity’s Retirement Quick Check calculator says that a 50-year-old person making $100,000 a year with $700,000 stashed in retirement accounts, saving $15,000 a year, would still fall short of the $2.8 million goal that would provide the necessary monthly retirement income of $7,408 that it sets. Its calculations do not include Social Security payments.

Fidelity actually recommends saving about $1,000 a month more. It also encourages this person to save more even when more than enough has been saved. It recommends putting away up to $9,749 a month on top of the $15,000 a year already being saved, an impossibility since that would more than consume the person’s entire gross income.

Mr. Kotlikoff’s ESPlanner software, taking real estate holdings and life insurance into account, says the person could cut back on savings by $10,000 a year and still have enough for a monthly income of $6,000 at retirement, the amount his calculations deems adequate to live on given prior consumption patterns.

Mr. Kotlikoff is trying to sell his software, called ESPlanner, to large employers as well as to the financial services industry. He has made no major sales so far. It is also available to individuals at for $150.

The financial planning industry prefers to characterize itself as cautious. William Ebsworth, chief investment officer of Fidelity Investments’ Strategic Advisers division, which runs retirement programs, said, “We take a very conservative approach,” preferring to err on the side of having money left over at death rather than risk running out before then.

“We believe in the research we’ve done and that others have done that Americans aren’t saving enough,” he said.

Read More......

Friday, January 05, 2007

How I Discovered the Gold Bubble

I have been investing in the stock market and one of my investment "finds" started to have a sell-off when I thought it was undervalued. I needed to be sure that I had properly assessed my stock of interest, so I started on a journey of comparing two stocks for market valuation.

The stock that interested me is Northern Orion. The stock that I decided to compare it to was Goldcorp. I chose Goldcorp because Northern Orion owns 1/8th of the Alumbrera mine and Goldcorp owns 3/8th. It seemed that they should have similar valuation based on this one interest.

What I discovered was that Northern Orion was trading for about 10c on the dollar compared to Goldcorp. I still strongly believe that Northern Orion is undervalued, I never expected to find a gold bubble in mature gold stocks, one that in my mind is as serious as the tech bubble.

Read my analysis and decide for yourself. Aside from the copper concern, the majority of these concerns apply to mature gold stocks and will make them under perform beyond anyone's expectations.

The over valuation of Goldcorp

Goldcorp is a company with 702 million shares that took over Glamis in late 2006. Currently a check on any stock website is still not showing the 280 million extra shares from that takeover and is enormously understating market cap. At a share price of about $28.50, Goldcorp has a market Cap of $20 billion.

To understand why Goldcorp is overvalued, these things need to be examined and evaluated:

  1. The leverage of earnings of both copper and gold.
  2. The price elasticity of gold bullion to gold stocks, ie, market cap.
  3. The increasing cost of acquisitions.
  4. The roll of the life of a mine - increasing rates of depletion.
  5. The roll of lower quality gold properties.
  6. The roll of depreciating mines.
  7. The level of reserves to market cap.
Major Concern #1 - negative leverage of copper

When I looked at Goldcorp, it was prior to the Glamis merger. At that time I found from reading the financials that in Q2/06 64% of earnings came from one mine for Goldcorp, the Alumbrera mine, and for the first 9 months of 2006 60% of earnings came from Alumbrera. Alumbrera is copper, not gold. I'm not entirely sure for Goldcorp, but for Northern Orion in Q2/06 they got $4.44/lb average. When 60% of earning come from one mine, where the price of the commodity is going down, that is huge in terms of loss of income for the business.

Before the merger, there were 60% of the number of shares that there are now. This means that for the year, it can be expected that about 1/3rd of earnings for the entire company will have come from copper.

If you look at the average price of $1.01 prior to the bull on copper, copper increased to roughly 440% of its previous price. I truly believe this leverage effect of earnings on Goldcorp has been grossly under appreciated in terms of how Goldcorp can never again have the stellar performance of the past.

Alumbrera has a twofold effect on earnings for Goldcorp. First, for 2005, the earnings were not subject to the 20% royalty, so earn estimates for Goldcorp for Alumbrera for 2005 based on those copper prices will be less. The upside is that 2006 only saw gross earnings without that royalty payment for Q1, so 2006 earnings are not completely plumped up by an unrealized 20% decline in copper prices due to the royalty kicking in.

The second effect is that copper prices are going down and copper LME stocks are going up. Traditionally demand for copper is lower this time of year, so even though copper stocks are going up, that may turn around this quarter, but copper stocks are increasing rapidly. The other thing about copper, every producer that can has increased their existing output as best they can. This has in the shorter term increased supply, but in the longer term shortens mine life.

I have not done the required homework, so I really don't know how much of the new production is new mines, and how much is increased output of existing mines. But, my overall sense from my reading is that producers have gone for the fastest path to increasing production, which was to eliminate inefficiencies in current operations, Alumbrera is not exception, production has been increase by 10%.

The other thing that may have happened as well is that mines have not kept up on maintenance the requires reduction in output. As copper prices decline, those scheduled maintenance needs will happen, so in some respects, In the short term there may be an unsustainable increase in production. If I'm wrong, copper prices will decline further this year and will probably settle in the $2.25 range. I do not see copper averaging at $3.40 as predicted in the BMO analyst report, but possibly in the $3 range, but the recent decline in copper price and increases in stock make that an unlikely prospect.

The effect of the decline in copper prices is enormous for Goldcorp, as such a high percentage of its earnings were from copper. With 168 million pounds of copper, every dollar decline in copper requires gold to go up $54 at current production rates just to offset it. So, from the high of $4.44 to today's low of $2.51, based on a production of 2.8 million ounces, gold has to go up $92/oz for Goldcorp's earning to remain constant. I have taken into consideration that 20% royalty in this calculation.

Major, Major, Major Concern #2 - reduced leverage of Gold.

This concern is more a concept than actual numbers, but this concept will play out in earnings. It mathematically has to. I believe that the concept of leverage of earnings is being utterly ignored in analysts and brokers alike, and not recognized in terms of its ability to never again give repeatable results regardless of what the price of gold does now.

The simplest and most dramatic way to demonstrate this concern is to do a mathematical analysis using ratios. I teach ratios to kids in grade 8.

Say you have a producer who when gold was $300/oz managed to make $10/oz profits and the earnings/share worked out to 4%. Say the share costs $1. Now say gold is $600/oz. So now profit is $310 and a simple ratio gives earnings (310/10)x4 = 124%. This kind of leverage of earnings made gold such a stellar performer up to now in the market, but mathematically, it can never be repeated. The leverage ratio here is 31, utterly enormous. Share price would then adjust, go up 31 times, to $31 and the return would again be 4%.

What has happened is share prices have adjusted to market cap and shares have gone way up, so earnings are again 4%. Market cap has also gone up 31 times. If it was 1 billion, now it is 31 billion. Keep everything else constant, costs are still $290 for the sake of this analysis of the reduced effects of leverage.

So, now say gold goes up another $300, to $900. Now profit is $610. The leverage effect is now (610/310)x4 = 7.9%. The leverage effect now is 1.97. The reduced leverage effect of increasing prices is 31/1.97 is 15.8. This is a decimal number. I also teach percents to kids in grade 8. This is a reduction of leverage of 1580%, providing costs remain constant.

Leverage of earnings early in the bull run played a dramatic effect on the increase in earnings on gold shares from increases in gold prices in a way that I believe is *unrecognized and unrepeatable*.

This incredible leverage of earning early in the bull run, in my assessment, is probably responsible for erroneously justifying P/E of 25 to 50 are acceptable for gold stocks because profit grow rapidly with increasing gold prices. The stellar leverage is a one time only deal. It declines further with every dollar increase in the price of gold.

Major Concern - Price Elasticity of Bullion versus Market Cap Concern

This is a simple mathematical analysis that I've talked about with high school students in the classroom in terms of what I see happening with gold stocks in general.

Take gold at say a price of $625/oz. Say you buy an ounce and the gold price goes up to $725, or by $100. Your investment has increased by 16% and you own the gold bullion.

For simplicity, say the market cap of Goldcorp is $20 billion (it was very close to that). Their production forecast is 2.8 million ounces of gold, which at @ a $100 increase in the price of gold would bring in an additional $280 million. So, the absolute value of how much earnings could go up relative to market cap is 280/20000*100% = 1.4%. So, if earnings were 4% they could go up to 5.4% if gold went up $100, but taxes also have to be paid.

The price elasticity of the raw numbers of what you actually have is the bullion is 11 time better to own right now than the gold stock, if you believe that gold is going to go up in value.

What is really remarkable here, is that not only is the level of earnings pathetic with the stock in comparison to bullion, you not longer own the gold, or essentially you have a very negative return. The gold has been sold.

Major concern - Increasing cost of Acquisitions

The cost of replacement properties has increased dramatically. I've pasted a recent report at the end. At the beginning of the bull run reserves cost about $33 oz. The Glamis take-over cost $175/oz. This is around $140/oz increase in acquisition costs.

The exact numbers don't matter, for simplicity, there is about $140/oz increase in gold replacement costs. Previous analysis was just looking at all things constant. All things aren't constant, and in fact work against profitability. Costs are increasing. Gold needs to go up to about $750/oz just to maintain earnings in terms of what those replacement cost are.

For Goldcorp, $140/oz in increased costs translated to 2% less to earnings per share.

Major concern - The life of a mine - increasing rates of depletion

Some of the spins I've read on the life of mine gives that a short mine life is a good thing because mines stop producing and it gives constant demand.

My spin on it is very different.

Red deer, a Goldcorp's second largest contibutor to earnings, has a mine life left of 12 years. Alumbrera has a mine life left of 10 years. Prior to the merger, those two mines were making 80% of Goldcorp's earnings. There are 23 properties listed. It means that one, and sometimes two mines need to be built every year just to keep up, never mind growth. Replacement is enormous...

In the shorter term for Goldcorp you see production going from 2.8 million ounces to 3.5 million ounces. From that point on you see a rapid decline in output due to the end of the life of the mines, with 60% of the 3.5 million ounces in mines that come to the end of their life within 12 years.

The rate of depletion of Goldcorp gold reserves without replacement looks something like this:
2005 - 40.5 million ounces
2006 - 38.5 million ounces, 2 million mined, depletion, 5%
2007 - 35.7 million ounces, 2.8 million mined, depletion, 7.3%
2008 - 32.6 million ounces, 3.1 million mined, depletion 8.6%
2009 - 29.3 million ounces, 3.3 million mined, depletion 10.1%
2010 - 25.9 million ounces, 3.4 million mined, depletion 11.6%
2011 - 22.4 million ounces, 3.5 million mined, depletion 13.5%
2012 - 18.9 million ounces, 3.5 million mined, depletion 15.6%

This means that Goldcorp is in a squeeze position of having to constantly be acquiring new properties to keep this monster machine going. It puts Goldcorp at major risk for increasing costs, and indeed, the costs never stop because of the constant need for recapitalization.

Major concern - depreciating mines

Mines are depreciating assets. The average life of a gold mine is 14 years.

To my way of thinking in terms of valuation, that means that earnings need to be 7% to make up for the average depletion rate plus inflation plus whatever it is you expect for the risk you take. Strictly my opinion here, but without strong other mathematical reasons and evaluation, a P/E of 10 is the minimum as to where you start, and then make adjustments up or down based on the fundamentals of the gold stocks. How much is being added to reserves and how much is being mined. If new reserves are being added at the same rate as the depletion, a P/E of 12-15 may be justified.

Another way of looking at it for Goldcorp based on the 41 million ounces of reserves and 3.5 million ounces of production fore casted in the future, well, that means that in 41/3.5 = 12, so in 12 years all you own is empty holes, with the gold all mined and sold.

12 years of earnings at 3%, if Goldcorp can even manage that, gives earning returned over the life its reserves that is only 36% of market cap. With a P/E of 12 you'd get 100% of market cap returned, with no time cost of the investment. With an estimate of 2006 earnings at $1.03, a P/E of 12 would give a share price of $12.38.

Goldcorp has a higher rate of depletion than average, so imho, even a P/E of 8 for it is generous.

Major concern - Lower quality properties available for replacement.
Again, from the source below, there has been a drastic reduction in property finds with more than 2.5 million ounces. With production rates fore casted to be going up to 3.5 million ounces, there needs to be 1-2 of these properties per year found and purchased just as a replacement activity. The low supply should further increase costs of acquiring these properties.

Lower quality properties generally means higher mining costs.

Major concern - value of reserves to market cap

Goldcorp's web site reports for 2005 the following reserves:

40.5 million oz gold @$425 = $17 billion
687 million oz silver @$10 = $6.9 billion
1.5 billion lb copper @$1.35 = $2 billion
3.7 billion lb lead @$0.50 = $1.9 billion
8 billion lb zinc @$1.25 = $10 billion
Total: $38 billion

It isn't corrected for the 2 million ounces of gold production for 2006, but that can slide...

And there are properties that haven't been properly assessed. There may be 10 million ounces in those properties, or there may be 100 million ounces. The properties have not be assessed.

However, what they can show gives a mere 2.2 times the market cap (using $17 billion market cap).

It seems prudent that market cap to what they can show at bearish prices should be at least 5 times the known reserves. This valuation alone puts Goldcorp's share price at $10.80.

Summary of concerns about Goldcorp
  • Negative leverage of copper - gold must go up $90 to cover.
  • Declining leverage of gold - leveraged increases in earning can never match early performance -- it is mathematically impossible.
  • Price elasticity of the bullion is 11x that of the stock.
  • Increasing cost of acquisitions means that gold must go up $140 just to cover.
  • Depreciation of mines is higher in the gold industry than any other mining industry.
  • Quality of replacement properties is declining, meaning costs will increase.
  • Availability of replacement properties is declining meaning acquisition costs can further be expected to increase.
  • The ratio of reserves to market cap for Goldcorp is disgraceful.

At the end of my analysis of Goldcorp I was truly horrified that anyone would be recommending this stock. Certainly if any of my analysis has merit, many reputations will be seriously hurt. But personally, I wouldn't buy Goldcorp at $10. I simply don't see growth potential at that price.

My Conclusions:
  • Gold prices must increase $230/oz to maintain earnings for Goldcorp.
  • Assets are depleting at a much higher rate than earnings.
  • Goldcorp is trading at about 3 times its value.
  • All Gold companies are facing increasing costs, reduced leverage, and greater difficulty for finding replacement properties.
(stocks with higher costs to at the start of the bull run have not increased to the degree that low cost producers increased, they simply never had the same leverage of earning to pump up their stock prices.)

The Under Valuation of Northern Orion

I stated that I saw Northern Orion has being grossly undervalue. All of its earning come from copper, so it too should expect much lower earning from its existing operations. My interest in Northern Orion came not from it current earnings, but it massive reserves and massive growth prospects, comparable to the potential of Goldcorp 6-7 years ago. Northern Orion has massive increase in earning opportunity even in a declining-copper price market.

Points that favor Northern Orion
  1. Market cap to reserves is enormous.
  2. Strong cash position.
  3. Expected cash from warrants can provide some capital costs.
  4. Good cash flow from Alumbrera.
  5. Aqua Rica property is well studied and Northern Orion has applied for building permits.
  6. Production increase is forecast to increase by 660% when the new mine starts.
  7. Low cost producer because of net credits of gold and molybdenum.
  8. Lower depletion rates.
Reserves to Market Cap for Northern Orion

Northern Orion has two properties, its 1/8th interest in the Alumbrera mine and Agua Rica.

The Alumbrera mine has 10 years of life left, Northern Orion's share is 50 million pounds per year of copper and 75,000 ounces of gold, exactly 1/3 of what Goldcorp gets from this mine.

Simple extrapolation, total reserve of this property is 1/2 billion pounds of copper and 750,000 ounces of gold, which at $1.35 for copper and $400 for gold is $0.675 billion for copper and $0.300 billion for gold, or about $1 billion.

The Agua Rica property is Northern Orion's hidden gem.

The feasibility study gives this total as to what can be mined over a 23 year period. This is more conservative than just looking at the reserve because recovery rates are taken into account. There are 6 million ounces of gold in the reserve, but only 3 million ounces are considered recoverable as about 50% of the reserve is not recoverable in the mining process. There are 13 million ounces in the resource. There are 21.4 billion pounds in the resource for copper and 1.7 billion pounds for molybdenum.

The recoverable metal estimates for Agua are
7.6 billion pounds of copper @1.35 = $10.3 billion
3 million ounces of gold @400 = $1.2 billion
360 million pounds of molybdenum. @12 = $4.3 billion

The two properties combine give $17 billion at $1.35 for copper, $12 for molybdenum and $400 for gold.

Diluted, Northern Orion has 221.5 million shares. At $3.70/share that gives a diluted market cap of $820 million ($560 million undiluted).

So, at bearish prices reserves to market is 21 times. A valuation of 1/10th production forecasts at bearish prices gives a valuation of $7.40.

Strong Cash Position and Warrants

Northern Orion has $180 million in cash in the bank. Should the fully diluted market cap be realized, it will have an extra $160 million from warrants. That's $340 million dollars, leaving only $400 million of market cap for valuation of the rest of the assets.

If you take the bearish value of what's in the ground, $17 billion and compare it to the rest of the market cap, well, that's 42 times the market cap less cash position.

Strong cash flow from Alumbrera

For 2005, with average copper prices at $2.37 equity earning were $46,755,000, and cash flow was $75,500,000. Earning per share at this price was $0.31. This is in the "ball park" of where copper prices can be expected and cash flow for the size of the company is strong.

Over the three years to bring the new mine to production, it is reasonable to expect another $150 million to retained earnings which can be used towards the construction costs of the new mine. Quarter 2/06 had cash flow of around $56 million alone. This drastically reduced estimate takes into account strong declines in copper prices, but is still strong cash flow.

Aqua Rica is ready for building.

The Aqua Rica property has an strong investment in drilling and feasibility studies and is at the point that permits have been applied for to build the new mine. The down side is that it is expected to take 8-10 months to get the permits approved.

Production growth is enormous compared to current operations.

The new production is expected to be:
  • 368 million pounds of copper
  • 120,000 oz gold
  • 15.4 million pounds of molybdenum.
The increase of cash flow at prices of $2 for copper, $425 for gold and $12 for molybdenum is $736 million for copper, $51 million for gold, and $185 million for molybdenum, for a total of $970 million dollars.

At a price of $2.37 for copper Alumbrera earned $0.31/share. A simple ratio extrapolation for a $2 price with a 660% increase in production gives (2/2.37) x (7.70) x 0.31 = 6.5 x 0.31 = $2/share earnings. This doesn't take into account there would also be molybdenum, which is like a bonus production. 185/221.5 = $0.84, so earnings should go to somewhere between $2-3/share.

The cash flow situation is that Northern Orion will have in the range of a half billion to pay for the new mine and will need to finance $1.5 billion. Their assets and cash flow are strong enough to do this without further dilution.

The new mine production is going to generate a cash flow in the range of what Alumbrera generates, only this will be 100% Northern Orion owned. To put this into perspective, Northern Orion's cash flow can be expected to be in the range of 40-50% of Goldcorp's 2007 cash flow, yet it has a market valuation 1/20th of that of Goldcorp. ($820m vs $17 billion) Further, the difference in the mine life (23 years) and availability of replacement reserves means that Northern Orion would not be subjected to they same types of increasing costs.

Low cost producer due to gold and molybdenum cash credits, lower depletion rates

Aqua Rica's cash costs for production would make it one of the lowest cost producers. This is the type of circumstance that led to the stellar growth and returns for Goldcorp, with a difference, depletion rates are lower. After the new mine is built, the shorter term, depletion rates are very high and cash flow is higher. Total production for 2012-2016 for copper would be 418 million pounds. It declines to 368 million pounds in 2017 when Alumbrera has come to the end of its life, and in 2022 the highest streams of copper are expected to be mined and production further declines to 300 million pounds for another 13 years.

The rate of depletion of Northern Orion's copper reserves looks something like this:
2006 - 8.1 billion pounds
2007 - 8.05 billion pounds, 50 million mined, depletion, 0.6%
2008 - 8 billion pounds, 50 million mined, depletion 0.6%
2009 - 7.95 billion pounds, 50 million mined, depletion 0.6%
2010 - 7.7 billion pounds, 250 million mined, depletion 3.1%
2011 - 7.28 billion pounds, 420 million mined, depletion 5.5%
2012 - 6.86 billion pounds, 420 million mined, depletion 5.8%

The cash flow is such that capital cost can be paid back while there is the higher production from the new mine as well as the continued cash flow from Alumbrera.

With longer mine life, Northern Orion is never in the type of squeeze position that mature gold stocks are in. Over the long term, they are not subjected to the same squeeze to keep production going to ensure maintenance of earnings, never mind to increase them.

Summary of under valuation of Northern Orion

  • The value of what's expected to be sold at half of today's market prices is $17 billion, 22 times the diluted market cap, and using a value of market cap being 10 times bearish price estimates give a today value for Northern Orion of $7.40.
  • Earnings per share can be expected to increase to about $2/share even if copper is $2/lb. With a target P/E of 10, once production is in full swing, target price can be $20/share. With a target P/E of 8, target price can be $16.00.
  • Northern Orion has a strong cash position, 35% of it undiluted market cap in cash, and 46% of its diluted market cap taking into account the cash from warrants.

My Conclusion: Northern Orion is grossly undervalued. It is a strong buy to $7 based of property holdings alone.

Everywhere I look, I think I've been conservative towards Northern Orion, and actually generous towards Goldcorp. For example, I've stated 10 times bearish prices for Northern Orion, using bearish prices, whereas for for Goldcorp I've suggested it should have 5 times the reserves at bearish prices relative to market cap. The estimate for Northern Orion puts copper at $1.35, highly, highly bearish. The estimate for Goldcorp uses reserve, for Northern Orion the estimate is corrected for the non-recoverable percentage in the mining process.

Copper prices have declined faster than expected, but there is a new mine entry barrier price. Northern Orion's entry price is much lower than average due to low production costs, and the enormous reserve was acquired at very low costs.

The recent Phelps Dodge merger puts an in the ground valuation for copper at $0.70. Their average production costs are $0.50/pound. With Northern's Orion's net of metal credits production costs at -$0.02, it is simply far more competitive.
Another tiny cap stock, Equinox, shows production costs of $0.70/lb.

Starting at a copper price of about $2.25 high cost producers start to have problems raising capital costs, and it increase from there. The sell off of Northern Orion indicates how true that is in terms of being able to attract capital for investment as copper prices decline. Copper was able to stay at around $1/lb for so long because land and capital costs had long been paid for, and the long life of mines enabled them to simply continue as ongoing concerns, without capital for replacement or new investment. And, at those prices, mines were going bankrupt.

Gold Takeovers Reach Record on Lack of New Supplies

By Choy Leng Yeong
Dec. 27 (Bloomberg) -- Gold-company acquisitions this year surged to the highest level in at least a decade, and the industry may continue its buying spree in 2007 as producers struggle to find new deposits.
Goldcorp Inc.'s $8.5 billion acquisition of Glamis Gold Ltd. was the biggest of 357 deals valued at a total of $24.3 billion this year, data compiled by Bloomberg shows. That eclipsed the $16.2 billion spent last year on 341 transactions, including Barrick Gold Corp.'s $10 billion purchase of Placer Dome Inc.
Producers are rushing to boost supply because mines are being depleted faster than new reserves are being found, and a six-year rally in gold prices is providing cash to buy assets. The number of discoveries of at least 2.5 million ounces has declined for eight straight years, according to Metals Economics Group in Halifax, Nova Scotia.
``The driving force behind the M&A is that you have difficulty finding new gold mines,'' said Graham Birch, who helps manage $27 billion at BlackRock Investment Management in London. ``It's all about trying to get access to reserves.''
From 1992 to 2005, the world produced 1.1 billion ounces of gold, or 1.8 times more than the new resources discovered among deposits of at least 2.5 million ounces, Metals Economics Group said.
The drop in new reserves followed years of reduced spending on exploration as gold fell to a 20-year low of $253.20 an ounce in 1999. Worldwide exploration budgets fell to a 12-year low of about $780 million in 2002, said Jason Goulden, director of corporate exploration strategy at Metals Economics.
`Scramble for Land'
``There is a scramble for land,'' said Ian Cockerill, chief executive officer of Johannesburg-based Gold Fields Ltd. ``From about 1996 until about a couple of years ago, there was a marked decline in the amount of exploration dollars. The industry is staring down the barrel of the gun that says, `Where are the replacement ounces coming from?'''
Gold Fields, the fourth-largest producer, earlier this month completed a $1.53 billion purchase from Barrick of half of the world's biggest deposit, the South Deep mine in South Africa. Gold Fields is buying shares in Western Areas Ltd., which owns the rest of South Deep. The deal will increase the company's reserves by about half.
The price of gold has more than doubled to $630.30 an ounce today from a 20-year low in 1999. The precious metal reached a 26- year high of $732 on May 12. The rally, fueled by investors seeking a hedge against inflation or an alternative to the dollar as it fell against the euro, has spurred demand for new reserves.
Cost of Reserves
The cost of reserves rose to a record $120 an ounce in 2005, compared with a low of $33 in 2000, said James Lowrey, a senior analyst at Metals Economics, which tracks more than 1,450 companies and deals of at least $50 million since 1995.
Gold Fields CEO Cockerill admits he paid top dollar for the South Deep mine at $104 an ounce. ``It is certainly one of the more expensive acquisitions that we have made'' compared with the company's historical average of $60, he said. ``But then again, it's a very special ore body.''
The mine, west of Johannesburg, contains as much as 29.3 million ounces, equal to about a third of the world's annual gold production. Gold Fields plans to study the viability of expanding annual production to 1 million ounces, from the 800,000 ounces expected yearly by 2011.
Vancouver-based Goldcorp spent about $175 for each ounce of reserves it acquired in the Glamis deal last month, and Toronto- based Iamgold Corp.'s $1.1 billion stock acquisition of Cambior Inc. valued each ounce at about $117, Lowrey of Metals Economics estimated.
Doing Deals
Doubling resources is a ``big rationale for doing this deal,'' said Goldcorp Chairman Ian Telfer, who has made more than eight acquisitions in the past four years. The purchase of Glamis helped Goldcorp overtake Johannesburg-based AngloGold Ashanti Ltd. as the world's third-largest gold producer by market value.
Citigroup Inc. was the top investment bank with five deals worth $11.6 billion, accounting for 48 percent of the market share. It advised Glamis on its takeover by Goldcorp. JP Morgan ranked second with $11.4 billion and seven deals, including Glamis.
Global gold production in the nine months ended September fell 2.2 percent to 1,804 metric tons from a year earlier, London- based researcher GFMS Ltd. estimated. The lack of new supply will help boost gold prices by $200 over the next two years, topping $800 an ounce, Telfer said.
``There is definitely a sense that the industry -- which is really good for gold -- is kind of flat to shrinking,'' said Barrick Chief Executive Officer Gregory Wilkins. ``Placer was important for positioning the company for dealing with the industry challenges.''
Gold-Company Shares
Shares of Toronto-based Barrick, which completed its acquisition of Placer Dome in March, rose 6 percent this year. Denver-based Newmont Mining Corp., whose bullion sales may plunge 14 percent this year, has fallen 15 percent, the biggest drop among the 16 companies in the Philadelphia Stock Exchange Gold and Silver Index.
Newmont, which spent $225 million to boost its stake in a mining project in western Australia this year, cut its 2006 sales forecast three times, most recently in September, because of lower output in Ghana and Uzbekistan. The company said Sept. 27 that its gold sales may fall 14 percent this year to 5.6 million ounces from 6.5 million in 2005.
Freeport-McMoRan Copper & Gold Inc., owner of the world's biggest gold mine, last month agreed to buy copper producer Phelps Dodge Corp. for $25.4 billion. Kinross Gold Corp., Canada's third- biggest gold producer, agreed to purchase rival Bema Gold Corp. for $2.84 billion in stock to expand in Russia.
Barrick's Wilkins said his acquisition strategy won't be affected by short-term changes in prices, which have fallen 14 percent from the 26-year high reached in May.
More Bids
Barrick may make a bid for New Orleans-based Freeport to boost reserves and lower operating costs, CIBC World Markets Inc. said in a research note on Dec. 15. Both companies have declined to comment. Barrick on Dec. 7 failed in its $1.71 billion hostile bid for Vancouver-based NovaGold Resources Inc.
Kinross Chief Executive Officer Tye Burt said takeovers may get a boost from the recent slump in prices.
The decline may bring ``more targets into a price zone'' to encourage acquirers, Burt said. ``In a strong commodity price environment, it's always tough to reach price agreements. Everyone's trying to protect their production profiles.''

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