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Iamgold (NYSE:IAG) has taken a beating with the recent drop in gold prices losing about two thirds of its market value in just a year.


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SA author Hebba Investments did a terrific analysis of the all-in cost of producing gold a short while ago and determined that Iamgold's true costs have run between $1,168 and $1,496 an ounce in the past 3 years.

With gold prices now in the $1,300 range Iamgold seems to be bleeding badly and it should be no surprise that investors have run for the hills.

For the purpose of this analysis, I am going to assume that the current Iamgold drive to reduce costs will have some success and they can get their costs down to $1,250 an ounce and keep them there for the next several years. Ambitious, no doubt, but this assumption is certainly with the bounds of reason and consistent with the company's own estimates of all in sustaining costs of between $1,200 and $1,300 per ounce of gold.

Iamgold has a nicely balanced portfolio of gold producing mines with its production split 43% in North America, 30% in Africa and the balance in South America. It has a reasonable balance sheet with $650 million of debt due in 2020 offset by an equivalent amount of cash. Total liquidity is about $1.6 billion including unused credit facilities.

Annual gold production of about 900,000 ounces and reserves totaling almost 40 million ounces make it a long lived set of mines and a good way to play gold if you are a gold bug.

I like to stay away from gold unless it is really in the dumps. I don't understand it or why investors value it, since it has few industrial uses and is no more linked to anything I value than currency and currency seems a bit arbitrary with many countries in danger of being unable to repay their sovereign debt and likely to print a lot more currency to inflate their way out of the hole they are in. Many observers think that is a case for higher gold prices. Certainly history has seen gold viewed by many as a store of value. I am not so sure but that is irrelevant to the theme of this article.

My take is this. If gold prices do move higher, Iamgold is in a pretty good spot to capitalize. The table below shows the sensitivity using a rather arbitrary 10 times cash flow as a proxy for the actual value of the company and $1,250 per ounce as the cost of producing gold all things included.

Gold Price

Production

Revenue

Costs

Cash profit

Value (10x)

$1,000

900,000

$900

$1,125

($225)

Hope

$1,100

900,000

$990

$1,125

($135)

Hopeful

$1,200

900,000

$1,080

$1,125

($45)

Whew!

$1,300

900,000

$1,170

$1,125

$45

$450

$1,400

900,000

$1,260

$1,125

$135

$1,350

$1,500

900,000

$1,350

$1,125

$225

$2,250

$1,600

900,000

$1,440

$1,125

$315

$3,150

$1,700

900,000

$1,530

$1,125

$405

$4,050

$1,800

900,000

$1,620

$1,125

$495

$4,950

$1,900

900,000

$1,710

$1,125

$585

$5,850

$2,000

900,000

$1,800

$1,125

$675

$6,750

With 377 million shares outstanding Iamgold has a current market capitalization of about $2 billion. If you assume a value of Iamgold's Niobium interest of about $450 million (it has operating profit of about $75 million annually and six times is a sensible multiple) and another $200 million for its gold inventory it seems the market is implying a gold price of around $1,400 for its current valuation of Iamgold.

The spot gold price today is $1,338 so perhaps this crude analysis is imprecise; perhaps the market is paying a bit of a premium given the possibility of a bounce after such a precipitous fall; or, perhaps the market is implying higher future gold prices. Regardless, it is pretty clear from the table that Iamgold is highly leveraged to the price of gold. In fact, each $100 move in the price of gold roughly equates to a $900 million move in the value of Iamgold.

In my view, Iamgold is dead centre among the targets gold bugs should aim at when the gold price has fallen sharply. As a relatively high cost producer, with its costs not far from the current gold price, it has one of the highest amounts of leverage to gold price movements in the industry, in my view.

Of course, gold can go down in price as well as up, and may fall further. How can investors protect themselves? Complete protection is not possible, but some insurance can be taken out.

My view is that a strategy of a pair trade makes sense in the current gold environment. A January 2015 call on Iamgold at a strike price of $8 is about $0.70 bid. If an investor buys the stock at its recent price of $5.35 and writes a January 2015 call at the $8 strike on half the position they will get a bit of a cushion if the gold price remains low for the next year and a half. If gold rises and Iamgold rises with it the investor would have given up any gain beyond $8.70 on half of their stock, but a move from $5.35 to $8.70 in 18 months is still respectable and any further gain will be earned on the other half of the position.

Iamgold currently pays a dividend amounting to about 4.7%. If gold prices continue to fall I doubt the dividend is safe so I ignore it in my approach to the stock.

Of course, there are many ways to play. Bottom fishers often catch bottom-dwelling fish and are unhappy it is not trout. We may be a long way from a bottom in gold, or it may be close at hand. I don't know. But, based on its leverage to gold prices and the prospects of sustained "money printing" by central banks, I have a long position in IAG.

Disclosure: I am long IAG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Iamgold's Leverage To Gold Prices Makes It A Good Speculative Stock For Gold Bulls