Tuesday, 31 January 2012

Gold Miners in a Safe Jurisdiction - Don Coxe Basic Points - Mainstream Investors Look to the Gold Miners

Reported by Mineweb :
Don Coxe, a widely followed and respected Canadian investment manager, in his Basic Pointsurges investors to emphasize miners over bullion. The key quote,

"What was most hurting gold shares recently have been the high-profile price plunges for shares of some high-profile producers with reserves in the ground in politically risky regions," Coxe noted. "It is absurd that investors are selling shares of companies which have, as a matter of policy, avoided investing in those high-risk countries."
"These disappointments should lead to huge outperformance for the companies who have the least endogenous risk, and we believe that will happen this year," he predicted.
"Gold has in the past decade evolved from being a curiosity to a speculative investment to a sound investment," Coxe said. "It is now becoming a necessary investment, as central banks print money prodigiously-and promise to continue."
"Emphasize the miners at the expensive of the bullion ETFs," Coxe stressed.

Price plunges for shares of producers with reserves in the ground in politically risky regions probably points to Kinross in particular, who have pursued aggressive acquisitions in "frontier" regions. Iamgold and Medusa have suffered too on potential political risks.

Kinross awaits Ecuador's positioning for the huge ex Aurelian deposit and also operates mines in Russia. Given Russia's history with BP in the oil industry one should be wary of investments in the enormous deposits, (often listed on the London Stock Exchange), held by Russian miners. The risks in Africa vary by region, but these countries may come under most pressure to tax the miners, indeed the IMF was encouraging tax increases.
Both China and Russia seem likely to see gold production strategically and perhaps prevent exports.

I see tax increases as a risk for all miners but especially those in countries with struggling economies or those which are highly indebted.
Countries with large exploration potential or mines due for development and production may lie low to ensure development progress before increasing tax takes. I like Canada here on a number of fronts, with lower debt and deficit risks and enormous resources and prospectivity to encourage development ahead of heavy taxation.

Companies who have "the least endogenous risk", in the safe jurisdictions, should include the Canadian and US Miners and developers listed around this blog, though sub-regions of  many countries encourage and discourage mining. Quebec in Canada, Nevada in the US and Chile are regularly seen as good place to mine..
Discussion of other countries here by Jack Caldwell
The Fraser Institute Report on Mining Risk in Frontier markets should mark your card here.
Inca Kola discusses Latam risk from the Fraser Institute report here. Showing Chile, Mexico, Columbia, Peru, Brazil as the best risks.
Certainly Mexico and Columbia are seeing very high levels of exploration though some regions have problems with gangs etc.

Coxe sees monetary policy in Europe and the US making Gold a "necessary" investment for pension funds.
This fits with Jim Sinclair predicting that Mainstream Entities will now enter the gold market as the Fed promises low interest rates and inflation, i.e. negative real rates until 2014.
Pension fund investing concentrated in this area, rather than spread across all the other "productive" hard assets at risk from a weak economy, would open up large pools of capital seeking entry to a relatively small sector.
Mining equties could fit with a number of investment mandates, especially if they become dividend paying and start out as "value" investments, whereas bullion is a "specialist" investment.
As at Jan 2012 
Apple's profitable gadgets give it a market cap of >$400bn.
Barrick is $50bn   -   Newmont $30bn   - Goldcorp - $40bn  - Newcrest $30bn
The top 4 major gold producers combined are approx 1/3 of an Apple.
Adding together the entire list of Gold Miners at Mining Feeds and adding on the big South Africans AU, GFI, HMY, at 30th Jan 2012 I came to an entire market cap of $354bn. So less than Apple alone for most of the publicly investable gold mines of the globe, Canadian Cos, US and Australian. The Producers, the mid-tiers -the large deposit developers, the explorers, the prospect holders. See Spreadsheet
For some months David Einhorn has bet that miners will beat gold.

A number of investors are seeing value in the miners and expecially the junior gold miners and explorers if gold has established a price base at $1500.
Brent Cook discusses the value left after investors bailed out of good companies last year. Glad to see I'm in good company with Brent Cook on the portfolio losses front here, kept hoping for those gains in 2011....

If the mainstream, pension funds etc,  first enter gold mining investments through the high capitalisation majors we should reach the tipping point of rising share prices and acquisition firepower for the majors against historically low valuations for the juniors.

We have seen the first merger and acquisition moves of 2012 with the completion of McEwen Mining's merger of US Gold and Minera Andes followed by Eldorado's bid for European Gold yet to complete.

Another key bid and we could see a snowball effect from the months of due diligence which have likely been seen during 2011 as junior mining valuations tumbled. A virtuous circle

  1. A large quality junior becomes a bid target
  2. Possible counter bids for the key best assets.
  3. Revaluation of other junior miners and similar bid targets
  4. An immediate revaluation of reserves on the major's books as single company risk is eliminated
  5. Rising gold prices strengthen major's profitability and share price value for acquisition
  6. The shareholders who have sold to the acquisition re-deploy capital within the junior sector where the pool of quality companies become depleted after several rounds of acquisition, the pool of potential junior investments becomes ever smaller.
  7. Mounting speculation over potential acquisition targets
  8. "Area play" / "similar style " companies are bid up
  9. Explorers emerge as high potential candidates for investment as gold in the ground is revalued upwards through the acquisition cycle.
  10. The market is not big enough for large pools of capital, price goes up, unless Bay Street and Howestreet can run their stock certificate presses at full tilt. As noted by Brent Cook there are already too many projects and too few geologists.

The majors own depleting, wasting, assets and need to replace each years production to remain viable.

If we see anything approaching mania in gold then valuation methods for miners will likely change to justify higher valuations, as in any mania, like dotcom values per click or per user.

Reserves will become valuable, even without an immediate means of extraction.
The "optionality" value, even of low grade deposits which may not but immediately economic, will increase.
Whereas currently standard NPV/IRR/DCF valuations look only at capex and cashflow from projected production levels one can begin to see valuation focus on a $/oz of reserves basis. "Anyone can spend $ to build a mine to get the gold out". Equally if a mine has been built already with "depreciating currency" and a fresh new deposit is waiting, especially with high prospectivity in the area, then again high valuation should be seen.

If we enter an inflationary environment then instead of discounting future cashflows gold can be viewed as moving in line with inflation and therefore the discounting rate can be changed relative to other businesses.

We should see major acquisitions and discoveries drive reversion to the mean in Gold : Miners ratios and then Miners : Junior Miners ratios.

Eventually any true mania will focus on the "prospectivity", the hope of the next big discovery.
Eventually Moose Pasture.

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