DRDGold A Buy As Bullion Hits Bottom

Aug.19.13 | About: DRDGOLD Limited (DRD)

With gold prices dropping to their lowest in two years amid the prospect of Fed tapering and import controls imposed by the Indian government, many investors have bailed out on the precious metal in fear of further capitulation. But, with gold down over 30% from its previous high set in September 2011, those investors are surely bailing out at the worst possible time.

For those still bullish on gold, the recent move down has been long coming and is nothing more than a normal correction during any bull market phase. All markets undergo such moves and once the bull market resumes, any gold miners left remaining will more than likely experience some form of reversal.

DRDGold, (NYSE:DRD), as a leader in surface gold tailings treatment has been cutting back exposure to its biggest cost makers and could be one of those stocks sure to benefit when the gold price moves back up.

40% drop

Gold's recent low of $1180 represents a near 40% drop from its all time high - a figure that has caused some investors to throw in the towel. However, the drop is remarkably consistent with previous downturns in the metal. Indeed, gold declined by around 30% only a few years ago at the height of the financial crisis. And if history is any guide, now could be the perfect time to get back into the market. Indeed the second half of the year has generally produced much stronger gains than the first half, largely as a result of it being the main season for weddings and religious festivals in China and India, who are big importers of gold.

Moreover, there are still amazing fundamentals that will see gold take off again once all the old longs are shaken out of the market. The simple matter is that even though gold may be down this year, on a long term basis it will most probably rise in price dramatically as a result of the aggressive monetary policy and currency depreciation strategies favoured by nearly all world leaders.

It is true that talk of Fed tapering has taken the shine off gold somewhat but this is only half the story. The Fed still maintain they won't reduce their asset purchasing strategy until unemployment drops below 6.5% - a statement that has remained unchanged for the last couple of years - and so when the Fed does begin to raise rates, it will only be as a result of rampant inflation - a condition in which gold is likely to be the biggest benefactor.

DRDGold

DRDGold stands out among many gold stocks as having a disciplined approach to cost cutting and money saving and is one of the reasons why it was recently able to rid its hands of the flawed Blyvooruitzicht mine, which will now surely have to be closed. And, by offloading its Zimbabwe assets, which it announced in April, DRD should reduce capital spending by some 50% in 2014. Add to that recent statements that show the company increasing its production in nearly all areas, the success of its Ergo operation and the stock begins to seem overlooked by the investment community. In fact the 3% increase in gold production over the first half of the year is superior compared to most of the gold miners and continues a trend that started in 2012.

Just take a look at Gold Fields (NYSE:GFI) - this is a stock that rebounded by 10% on Thursday - even though production was down by 11% in the last quarter.

As of last year DRD produced 135 708 ounces and declared attributable mineral resources of 37.6 million ounces, a feat that enabled the stock to advance by 35% even as the gold price flat-lined.

Since then, however, it has fallen back with the rest of the market as the gold price has crashed.

And now that the gold price has some room to move up, DRDGold will likely move up too. Or at the very least, it will recoup some of the losses that have seen the stock decline to the $5 mark.

Indeed DRDGold recently reported EPS that was 17% higher than the previous year, and has actually managed to increase operating profit in the third quarter by 5% - a number that would have been higher had it not been for strength in the South African Rand.

Risks

Of course, investing is never without its risks and the risks posed by small cap gold miners such as DRDGold are more than most. Indeed, research has shown that, historically, buying gold outright has panned out much better than buying the miners. That beings said, if you are able to pick the right miner you can make substantially more than the metal itself. Especially if that miner is beaten up in the first place.

Another risk associated with DRDGold comes as a result of its geographic location. As stated, DRD makes its money in South African Rand, which could cause problems if the currency were to strengthen dramatically against the dollar. Such a scenario could erode DRDGold's potential returns and even lead to unrest within the country itself.

Production costs

However, it must be said that South Africa, when compared to some of the other big gold producing nations, is politically more stable than most. And although there have been employment problems in the country, DRD is more sheltered than most as a result of it being involved in the treatment of gold tailings rather than having to employ scores of locals to work the mines. Furthermore, while it is true a strengthening in the Rand could cause production costs to soar, the South African Rand is at its lowest against the dollar in 18 months. Another reason why DRD could see its profits improve in the coming quarter.

USD/ZAR

With a forward P/E of just 7.68, potential cost base reduction of nearly 50% and numbers improving on several fronts, you can see why DRDGold moved up sharply Friday (when compared to other beaten up miners) as the gold price rebounded by 2%.

And it is the reason why the stock has more potential upside to come once the gold price resumes its bull phase. DRDGold, although not without risk, could offer a good addition to a portfolio that needs one or two miners to supplement its gold exposure. For the second half of the year at least, it should provide some solid returns.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.