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.''


armoredsaint said...

What are you smoking? Goldcorp is the cream of the crop in the gold sector and will soon hit 50 by june 07 IMO. Watch n learn!! Did you even finish high school?

Deborah said...

Thank you for your comment armoredsaint, do however think that comments that show the error in the analysis are far more useful than swinging insults.

Can you show me that there is about 100 million more ounces in reserves to counter asset to market cap concern.

Can you show that costs will actually be less than I suggest.

Can you demonstrate where the profits will come from?

Can you demonstrate that costs aren't going up?

You didn't counter a single statement but just continued with they hype and hysteria, echos of the tech bubble...

But hey, did you read Georg Wilhelm Hegel in the introductory post?

Even more interesting, go research the gold rushs of the past, see how it utter collapsed when technology fell behind the ability to extra the gold, and they couldn't find quality gold reserves any more.

The parallels in what's happening here are screaming for history to be looked at and learned from.

Deborah said...

That should read extract the gold...

Bushnigger said...

Red Deer is in Alberta, Canada. The richest gold mine in the World is in Red Lake, Ontario and belongs to Goldcorp. I am a Rich Man thanks to Goldcorp, and you should stick to COOKING; leave INVESTING TO REAL MEN WITH BALLS.

actualstuff said...

I think you may want to take a closer look as to what constitutes a "bubble" and what does not. Returning to levels keeping with inflation after 20+ years of being down, down, down is hardly a bubble.

When you start seeing companies adding "Gold" to the end of their name like companies did with dot com in the late nineties, that might be a sign.

You may also want to compare the capitalization involved in the gold market. It's tiny. Super tiny. Compare it with the market cap of tech stocks in the late nineties. Is the typical investor in gold? Do they know anything about it at all? Is the type of money that was going into tech and telecom in the nineties going into gold stocks?

Hardly. While some seriously leveraged hedge fund players have been speculating in commodities, the comparitive market cap is negligible. Mom and Pop investor are not in gold like they were in tech during the 90s. The book shelves even in Vancouver where you are (the gold stock capital of the world) are not full of books on how you can quit your day job and invest in gold. Those ones are still about real estate. When the Barista at Starbucks advises you on the latest greatest gold IPO, then it's time to start talking bubble.

That said, I think you put forward some good points about Goldcorp compared with the juniors. They're a bigger company and generally track with the price of gold. All the bigger ones do. For bang for your buck, you're better off in so many other smaller companies.

What you did discover though, was the gold opportunity. Very few have though-- so congrats for that.

Deborah said...

Ok Bushnigger, but your richest mine in the World only accounted for 25% of Goldcorps profits for the first nine months of 2006, and that 3/8th ownership of Alumbrera accounted 54% of the earnings.

Truly, Coppercorp would be a better name.

Deborah said...


First, this is about the stocks, not gold bullion. GLD is a gold backed stock where they back it with physical gold in a vault.

A mine is a business. It reduces its "holdings" in gold with every sale it makes. That is more comparable to when the US treasury started selling of its gold that backed currency. If that isn't a good idea, what makes owning a gold stock a good idea?

The business dynamics.

I think the type of investor who is into gold stocks is trying to protect from currency devaluations. And gold bullion may very well do that.

Gold stocks were highly successful because the business dynamics were such that you truly had to be incompetent to not succeed.

The had low cost aquistions, they had low profit margins which offer enormous leverage of earnings, and they had enormous increases in the price of gold. Their production levels weren't grossly out of line with their reserves or market cap.

Now, costs are way up, leverage of earnings is anemic, increases in gold price are relatively smaller ($10 on $300 is 3%, but on $600 is 1.5%), market caps are inflated.

Yes the big gold stocks track with the price of gold, but will they continue to do that when earnings are way down?

I predict 10-13 cents for Goldcorp for Q4/06.

But looking back, I didn't clarify that I also think the juniors will do better. They have enormous growth in production relative to market cap to off set the declining business conditions.

And, only the juniors that actually have a feasible property go on to production, so there is the enormous risk of investing in a junior that doesn't have a feasible property.

actualstuff said...

When I was talking about investors being into gold or not, I was talking about the entire sector. Physical, bullion funds, mining stocks, whatever.

As for what makes owning a gold stock a good idea is that when you can produce something for less than you can sell it for, you make a profit. These profits can then be reinvested back into future projects to continue the process.

Goldcorp isn't doing the best at making their business sustainable-- the bigger you get in the mining business the harder it is. Hence the article in your post about acquisitions among the majors. Goldcorp isn't a bad pick because gold is in a "bubble." It's a bad pick because they're not doing enough to replace their reserves with other low cost reserves. I think they overpaid for Glamis for example.

And you're right about juniors not going to production. Something around one in a hundred exploration stocks go into production. I'm a fan of smaller producers that are actually producing the stuff. Or late stage juniors that are in the middle of mine construction. If it never goes to production, all they were ever selling was a story.

But it all does come back to the underlying commodity. Gold producers are facing higher energy costs, labor costs, cap equipment costs, etc.,. This contributes to a higher cost per ounce which means that you need a certain grade and reserve size for it to be feasible under certain gold prices.

So why has gold gone to where it has? Is it done? Do the conditions that made it move up to the 600 mark still exist? What were those conditions? Are those forces stronger or weaker now?

Deborah said...

Gold can never perform the way it performed in the past. Mathematically it just can't, and it isn't just about the energy, labour and capital costs.

The buying of replacement properties is enormous... From $33/oz to the max of $175 for Glamis, but others have done $150. This is 500% increase in costs in one area. It is meaning that gold must go up over $100/oz to maintain. It means the little guys can never do as well as you would expect based on experience with the little guys a couple years back.

I can see how you would expect me to be talking about the entire gold sector -- no where did I clarify mature gold stocks. I do need to correct that.

But, I am expecting a number of mature gold stocks to crash and burn big time.

I'm very neutral about what I think gold bullion will do, pretty flat is what I'm thinking.

Deborah said...

I edited paragraph 4 today as my analysis applies to mature gold stocks, not bullion, and not the juniors. I was quite surprised I'd missed tying that in in my introduction and thank to actualstuff for pointing out that I had written my post to apply to the entire gold sector.

actualstuff said...

You bring up some good points. Especially about acquisitions. It's easier for the bigger companies to acquire than to explore and given the rise in gold prices over the last few years, they are paying a lot for it.

It really does come down to the price of gold.

The scary thing about commodities is that their cycles are so big that you've got to go back decades to find out what happens during bear and bull markets in commodities. Then identify factors involved and try to figure out if things are the same now as they were then and what it all means.

While there is jewelry demand, Gold is a monetary commodity. It's bought and held primarily as a store of value and a hedge against inflation. Central banks have been selling it or leasing it out for years because it just sits there otherwise. In retrospect it was a bad move-- like the scandal in Britian where they sold gold at the lowest price and it's more than doubled since then. The taxpayers were pretty ticked off.

But now, the 2nd tier central banks in Asia and the Middle East want back in. So does Russia. All the countries realise that US dollar hegemony might be ending and want reserves in another form. Euros and gold.

What exactly is inflation? Most people will tell you it's the rise of prices. That's actually the symptom. Inflation is an increase in money supply. It's not prices rising but the purchasing power of money declining because there's more of it being made each year than the economy is growing or the rate that goods are produced.

Take a look at the money aggregates of the countries on the planet. The Federal Reserve stopped publishing the figures but they're pretty simple to reconstruct. Countries are printing money at 7%-10% a year. Today's money creation is tommorow's inflation showing up in the CPI.

The media and central bankers say that inflation has been kept in check. But is that really the case? They keep changing the measure. In the US for example, if you take the CPI that was used before Clinton became president, today's CPI is 5.5% and rising. Now they talk about the CPI at 2%. Canada's CPI is at 2.1%. How accurate are these numbers really?

The government is on the hook for union agreements, CPP and more in terms of inflation adjusted payouts and COLAs. They also want to keep people's confidence in their currencies and look good for elections.

I think the price of gold is going to keep climbing and the moves (both up and down as it will be with incredibly volitility) will actually be more dramatic than the ones that got us where we are.

Money creation is up. World confidence in the US dollar is down. The US is borrowing at record levels and spending it on war. Central banks that used to talk about selling gold by the ton are now contemplating buying it back. Especially outside of Europe and North America.

As far as gold making new highs, I think we need to adjust it for inflation. Even using the dubious CPI numbers, we're no where near the high for gold in the 1970s. We are no where near gold rush levels.

You said that it mathematically "just can't". Is that really the case? How big is the gold market? How much gold is there? What percent of the world's capital would need to move into gold to move it? At what rate is that money supply expanding? At what rate is gold being mined? Where are the large deposits coming into production?

Commodity cycles tend to last a decade or more. The easy money making might be over. These cycles have stages and the easy money is made in the first stage where gold just goes up and everyone makes money. In the second phase we have extreme volitlity and big moves in the price of gold and the miners. The third stage is when mom and pop get in and we get the true bubble.

It's going to be hard to know when to get in and when to get out, but there's a lot of money to be made if one has the stomach to sit through the scary swings.

Sorry about rambling on so long. I enjoyed your comparison of Northern Orion and Goldcorp. I think the majors will continue to track the price of gold though, rather than get trashed. Expect more acquisitions and mergers and people ignoring the PE ratios, especially as we get out of the 2nd phase and into the 3rd in the next 2-6 years.

Deborah said...

I think there are a lot of linear concepts in people's minds being applied to how they think stocks will perform, where there is tons of leverage issues happening.

I think in people's minds they know what happened when gold went up $100, and they think the same think will happen. That's the second thing that I list. This is enormously significant, and to my way of thinking, the question I ask is where in anyone's right mind did the idea that it would ever be OK for a depreciating asset to trade below the rate of depreciation?

Leverage is the answer.

At the beginning of the bull profit margins were tight. After production costs there are a whole bunch of other costs.

So, you have say a $10 stock trading with a P/E of 25, and gold is $300. All costs and taxes are $290. Well, gold goes up $100 that first year. Now you have $110 going to profits, so profits can jump to 44% and the P/E dives to about 2. And an ill conceived idea is born, that trading on high P/Es is safe for gold because the price going up is going make profits go up enormously.

You can not assume the next $100 increase will do the same thing.

The stock price goes up to trade with a P/E around 25 again. Now the leverage is 210/110, so this time the P/E goes to about 13 instead and earnings were close to 8%. The second hundred dollar increase just didn't do much by comparison, it simply isn't a linear concept.

actualstuff said...

I haven't been on the same page as you-- I apologize for that.

You're absolutely right. The only advantage a mining stock has over another investment in the underlying metal is leverage.

And if that's not there, then what's the point of investing in the company?

Deborah said...

Here's a link to another's valuation, notice Goldcorp is close to the top in overvaluation.

Joe_5000 said...

A great article with well thought out analysis! This puts you on my favorites list for financial blogs.

Deborah said...

Thanks Joe :)

1200thoughts said...

At the time you posted this (January 5, 07), Northern Orion was at 3.50, now its at 5.50 and still climbing. (Look at that chart since your call!)

GG was at 25.5 and is now just under 24.50.

Incredible post.

Deborah said...

Thanks 1200thoughts.

I actually start writing about Goldcorp when it was at about $26US in November and it went up to about $31 before heading down.

I don't think this latest jump in the past week will be sustained. It would not surprise me to see this one below $20.

Watch FNX, it won't stay up either.