Home Builder Stocks Have Come Roaring Back....
Early last year sentiment on Home Builder, "HB" stocks was dismal. Short interest in many of the names was sky high. Companies like Standard Pacific, (NYSE:SPF) and Hovnanian, (NYSE:HOV) were trading near 5-year lows. Lumber suppliers to the HB industry, such as Louisiana-Pacific, (NYSE:LPX) was thought to be at death's door. Conventional wisdom was that new housing was not needed due to a large overhang of excess supply.
Most pundits believed a sustained recovery in housing demand would not occur before 2013-14. However, the smart money began buying housing units hand-over-fist in 2011 and never looked back. For example, Blackstone now controls a residential portfolio of $3 billion, [see link]. According to CEO Schwarzman,
"Blackstone is now the largest owner of individual houses in the U.S.," Schwarzman told CNBC's "Squawk on the Street", pointing to his company's $3 billion portfolio of residential real estate."
According to the Case-Shiller Index, Housing prices are up ~10% year-over-year through February, with Phoenix up 23% and Dallas and Atlanta markets registering the strongest annual appreciation since 2001 and 1992, respectively. Applying moderate leverage, Blackstone's returns must be quite impressive, especially given ample opportunities to borrow at extremely attractive mortgage rates.
Standard Pacific's stock has tripled and Hovnanian's has quadrupled since January 1, 2012. Likewise, lumber prices have more than tripled over the same period. Negative sentiment can, and frequently does, change over relatively short periods of time. As the saying goes, "the cure for low prices is...low prices."
Conventional Wisdom Said Natural Gas Prices Would Go Lower
And then there's natural gas, talk about negative sentiment, it was truly awful last year. In this article I wrote,
"Last year's average natural gas price of $2.77/mcf hardly tells the story. For much of the year the price was well below that, hitting a low of $1.82/mcf. Conventional wisdom said there was a glut of gas due to the, "shale gas revolution." Natural gas was so abundant that it was being flared because it wouldn't fit into fully-utilized pipelines."
Few questioned the reasoning behind this so-called shale-gas revolution thesis. Natural gas prices were stuck at $1.8-$3.0/mcf. Experts said prices would range from $1.5-$2.5/mcf for an extended period. Today natural gas prices are above $4/mcf, more than double last year's low.
What Does All of This Have to Do With Gold Companies?
Today, few sectors are loathed as much as the gold companies. Gold is last year's natural gas. Sentiment is abysmal, analysts are cutting targets, companies are scaling back and investors are heading for the exits. However, just like with the HB stocks, the stars are aligning for a robust recovery in select gold stocks.
After a brutal two-year bear market for gold companies, development projects are being delayed and canceled and funding for green field projects is impossible to find. Having failed miserably in delivering shareholder value, the majors are pulling back on growth cap-ex and exotic locales. Industry-wide cost inflation is running rampant, killing per-ounce economics, (fixed costs spread over lower volumes). Finally, there's increasing acts of resource nationalism around the globe, [see here], [here] and [here.]
Where's New Gold Supply to Come From?
A substantial portion of global gold supply comes from countries in Africa, Indonesia, Russia and the Dominican Republic, (among other challenging places), all of the above mentioned headwinds will wreak havoc on supply. Companies like Newmont Mining, (NYSE:NEM) and Barrick Gold (NYSE:ABX) are like aircraft carriers, they don't turn on a dime. Now that they have turned off the exploration spigot, it will take years before large green field projects are pursued again.
Even if the scourge of resource nationalism can be contained, the fix won't come cheap. Marginal production costs are in the $1,250 - $1,450 per ounce range, with several majors operating mines at even higher costs. Either gold prices will bounce back above $1,600 per ounce or supply in coming years will be well below expectations.
That's why I'm bullish on low-cost gold producers in safe jurisdictions with strong growth opportunities. One such company is Canadian Detour Gold, (OTCPK:DRGDF), a producer of ~300k ounces in 2013, rising to ~400k next year and a run-rate of 500k + ounces by 2015. The stock has been hit hard due to recently revised guidance. Initially at 350k-400k ounces for 2013, new guidance is for 260k-320k ounces. Total cash costs estimates were raised by $50 per ounce to $800-$1,000 from $800-$900.
Did this revised guidance, already telegraphed to the market, warrant a further 15% decline in the stock? Look at the math, 85k fewer ounces of production in 2013 at a $50 per ounce lower margin = $4.25 million of delayed cash flow. Does this hit to cash flow warrant the wipe out of $170 million in market cap? I don't think so.
The Elephant in the Room
Investors fear an equity raise will be required to provide a liquidity cushion for the Company's ramp up to a run-rate of 500k + ounces by 2015. Analysts suggest that $50-$100 million of equity might be needed. That would be dilution of just 4%-7%, hardly a reason to panic. For a company that analysts believe is worth $22 - $32 per share, i.e. a market cap of $2.6 - $3.4 billion, $100 million would not be the end of the world.
In the past week, Credit Suisse lowered its price target on Detour Gold to $32 per share, but stated that funding would only become an issue if gold prices average $1,300 per ounce or lower. The following research shops came out with notes in the past few days,
Macquarie said, "No change to our $22 target and Outperform recommendation. Our NAV estimate for DGC (based on the gold forward curve) is C$29.36/sh; the stock is trading at 0.35x NAV, the lowest in our coverage list..."
BMO Research expects Detour to "produce 288koz gold in 2013 at total cash costs of US$940/oz gold. Life-of-Mine production is estimated to be 14.2 million ounces of gold at an average total cash cost of $720/oz." BMO has a $26 price target.
Raymond James said, "Given Detour's size, advanced stage and stable jurisdiction, we use a target multiple of 1.1x NAV to arrive at our $26 target price. DGC is currently trading at 0.5x NAV, (0.4x at current spot prices)."
Detour Gold is soon to be a mid-tier producer with production of about 300k ounces in 2013. By 2015 the Company will be operating at a run-rate of 500k or more ounces. The stock has been killed along with gold companies not yet in production, with higher costs and/or with assets in challenging locations. As the focus by the majors moves to safe havens and higher margin mines, Detour will stand out on both fronts. This is a stock with fairly limited fundamental downside, but one that could double to $20 and still be priced below most analyst price targets.
Additional disclosure: I am long Detour Gold.