The Cream Of The Gold Crop

Includes: GLD, NGD, SLW, SUSA, VGZ
by: Andreas Spiro

In this article, I will highlight different gold/silver miners with innovative business plans worthy of mention and/or strong growth. Before I do however, I will endeavor to dispel a few common myths about gold and gold prices in general so that those interested in investing in gold stocks will have a better idea of the structure of the market they are entering.

First of all, the so-called gold (GLD) "bull market" that began in 2000 is qualitatively unlike any other bull market in recent history. That is not to say that it is "better" than any other bull market, but rather that what is driving it is something entirely different from what drives other bull markets.

A normal bull market is driven by a flush of investment and earnings followed by more investment to match in an industry that is making money. It signals that the economy is shifting resources to a certain sector, as is what happened when the public started to catch on to the Internet and money started flooding in. But there are two sides to every monetary transaction in any market, bull or bear. There is the good or service, and there is the money given in exchange for it, which is also, fundamentally, a good. In order to accurately gauge a bull market, you have to have a stable money-good with which to measure it.

Before 1971, when the gold window was closed, any bull market was essentially priced in gold because dollars were, by definition, gold. Since then, the nature of the bull markets themselves, have changed. They are now priced in paper, the supply of which has exploded at the touch of a button by the U.S. Federal Reserve, growing by $85B a month.

When we are talking about the gold "bull market," it could mean two things. If it was before 1971, we would simply be talking about a dollar bull market. Meaning, people would want to hold dollars, or gold, instead of stocks. Prices would go down, including stock prices, and money would have increased purchasing power. Now that we're past 1971, a gold "bull market" means that gold priced in paper is going up, or more accurately, paper, priced in gold, is going down.

While other bull markets are inherently fueled by increased investment and can only be nominally affected by price-inflation to push them a bit higher, a gold bull market works in the opposite way. It is fueled inherently by inflation and can only be nominally affected by increased investment or speculation. This is not just theory. It can be illustrated directly.

The price of gold is directly and heavily affected by the cost of mining it. If the average cost of mining gold goes up, the price of gold must go up with it. Otherwise, gold miners will stop mining it, supply will stop flowing, and the price will move up in response anyway. Price inflation makes gold mining more expensive, inherently making gold more expensive, providing a constantly rising floor to the price of gold below, which it cannot pass (about $1523 an ounce) in an inflationary environment, almost by definition. Anything above that floor is gold speculation, but the floor will keep rising steadily and fast if the Federal Reserve loses control of the money supply very quickly. If someone is trying to make the argument that gold prices are going to fall secularly, he is basically saying that the costs of mining gold are going to plummet. With $85B new paper dollars flooding into the economy every month, this is next to impossible.

The second important thing to realize is that using technicals to predict future price movements in the gold market is an exercise in futility. When you look at a chart of gold priced in dollars, the very picture of that chart assumes that the "dollar" is a stable unit by which one can measure gold prices. But in reality, it is not. A real chart of gold priced in dollars would have to be warped to varying degrees in different chart years by the amount of dollar creation in any given year. This makes technical analysis meaningless. Who can spot a trend line when your whole graph is warped along the X axis? Why is this not the case for other bull markets, where technicals can give valuable information? The answer is that the gold market is primarily moved by dollar creation. For other bull markets, dollar creation is only fuel for the fundamentals. For gold, it is the fundamental.

Now that this has been cleared up, here are some interesting picks: one, for its growth potential (following its next earnings report) and the other three, for its original and innovative business models.

Vista Gold (VGZ), combination miner investment bank and gold miner

Vista Gold's income statement, when you first look at it, can throw you for a loop. What it shows is zero revenues with substantial operating losses, but somehow, a net income of $51M last year. What you're seeing is Vista's business model in action. In addition to exploring its own mining assets, what it does is buy shares in mining projects of other companies it believes are sound investments. In this way, it is both a traditional gold miner as well as a mining company investment bank.

For example, along with numerous joint ventures with other private firms, Vista currently owns 28% of junior miner Midas Gold as of June 30, 2012. You'll see on its quarterly balance sheet fluctuating numbers regarding long term vs. short term investments which primarily have to do with the companies Vista is invested in and their valuations. In order to really fly though, Vista will need its chief mining property, Mt. Todd in Australia, to go online. Vista's uniqueness as compared with other companies is through is its two-pronged investments/direct mining combination approach which I haven't seen much of in the mining sector. That is why I mention it here. Its investments have not been sufficient to keep it consistently net positive, but they will continue to buy the company time until it can get its main projects online. If it can do that, gains could be huge. For a thorough analysis of the Mt. Todd prospect, see here.

New Gold (NGD), growth to continue after earnings dip

New Gold deserves mention because of its amazing growth since 2009. This company went from a loss of $194M to investing over $200M in hard mining properties and equipment, investments which bore fruit by the end of last year with New Gold net positive $179M. This shows how a traditional gold miner is actually supposed to grow. Invest in mining properties, run them well and they pay off continuously for years to come. This year's revenue is set to outdo last years' close to $700M, though income will be down. I suspect there will be a dip after the earning's report showing a drop in income, after which buying the dip would be a smart move.

Silver Wheaton (SLW) and the tax loophole

Silver Wheaton is a classic since 2004, but every time I look at its cash flow I can't cease to be amazed. Net income is up 366% since 2008. But that's not even the best part. For whatever crazy tax loophole reason, SLW pays phenomenally little in income taxes. Just take a look at its income statement and its income tax expenses relative to its operating income. It'll keep you wide-eyed wondering how the heck the company does it. The answer is on page 27 of its 10-K: Incorporation and operation in the Cayman Islands and Barbados, subject to minimal income tax. That's just got to make you smile.

Silver Wheaton doesn't mine silver. It provides juniors with the cash they need to mine its projects, in exchange for a right to buy silver at a large discount. Silver Wheaten revels in the resulting profits, assuming it picks a worthy junior, which it indeed has a good track record of doing. But the almost nonexistent income tax is the icing in the cake. This gives Silver Wheaton an advantage that almost no other mining company has.

If Uncle Sam catches on, I would sell, but I doubt they will if they have not done so already.

Southern USA Resources (SUSA.OB) and data mining

SUSA is one of those strange startups that can look a bit confusing and suspicious. At least that's what I thought when I took a closer look at recent press releases. This is not a company to bet the farm on, but I think it's worth a small speculative bet (don't go overboard) after short term overbought conditions due to some report that came out are eased.

I have seen a lot of gold miners in my day, but never have I seen something like this before. SUSA's business model, besides buying up mining property and equipment of course, is data mining in libraries for info on old abandoned Alabama mines. When I first saw this I started thinking, perhaps the company is on to something (emphasis mine):

Based on the Geological Survey of Alabama, gold mineralization in Clay County lies in the Northern Piedmont and Brevard Fault zone. Gold mined in the area comes from a series of quartz-gold veins. The company has recently discovered an old mine shaft, most likely abandoned in the 1800's, and based on new essay results evaluated by the Company, gold is very much evident in the areaso far preliminary indications are that the belt of gold bearing ore is approximately the length of the property and beyond and is approximately 6 ft. to 180 ft. wide/down, based on historical reports of elderly miners who have verbally confirmed this. This suggests that SUSAR No. 1 may potentially contain several hundred thousand ounces of gold when mined to depth.

Southern USA Resources is mining more than gold. It's mining into 150+ year old Alabamian mining records to pinpoint its geological search, old abandoned mining shafts and historical reports of miners from the 19th century. Why were these mines simply abandoned? It may have something to do with the 1849 California gold rush. Back then all people and investment money went out west just when these mines were being developed. No one has touched them since, but SUSA is going in, with plans for production in 2013.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

About this article:

Problem with this article? Please tell us. Disagree with this article? .