In my year-end recap, I mentioned gold mining stocks as possible opportunities in 2012. The miners as a group have lagged the metal's price run-up and with gold around $1600, some of these stocks may be safer ways to play the continued global economic uncertainty. Unfortunately, the 1st trading day of 2012 saw a big run-up in prices but with the sector's volatility, investors will most likely get another chance so it pays to be prepared. Two stocks in particular have shown up on my radar: Minefinders (MFN) and Allied Nevada Gold (NYSEMKT:ANV).
Minefinders was a portfolio holding as recently as August, when I was exercised out of my position by covered calls. It proceeded to trade almost up to $19 before recently experiencing a big drop down to the $10 mark. The company has been beset by some production setbacks but nothing on a scale to warrant a near 50% decline. There is some conjecture that share price action has been a result of analyst downgrades, most notably from respected precious metals analyst, John Doody of the Gold Stock Analyst newsletter. Apparently, analysts are tiring of management's inability to meet its own projections on schedules, production and operating costs but based on the company's track record, this should come as no surprise.
I first wrote about the stock over three years ago. Back then, the company was in a race to get its sole mine into production before liquidity ran out as management promised it would not have to resort to equity or debt issuance. I regarded this as a "line in the sand" as far as management's credibility was concerned -- no doubt, bringing your first mine online is a huge undertaking but they were the ones who said they could do it with resources on-hand. Failure to live up to their own projections implied that they were either poor at understanding the scope of their work or poor at execution -- perhaps even both. Eventually the Dolores mine was brought online but shareholders suffered 20% equity dilution in the process which shook my confidence that Minefinders' future projections and estimates could be taken at face value.
So I am not surprised at MFN's difficulty in meeting its targets -- it simply does not have a top-tier team in place. But that does not mean it is not worthy of investment if the price is right. With roughly 2M oz of gold and over 100M of silver reserves, I estimate the company's worth to be anywhere from $10 - $22 per share, depending on the price of gold/silver, with the low end being a fairly draconian scenario. Also note that despite its operating troubles, MFN still generated ~$67M free cash flow in the 1st 9 months of 2011, which equates to over 7% of current market cap so clearly there is value in the company.
In December 2011, I opened a long MFN position via May 2012 $10 naked put options for a $1.40 premium. If shares remain above $10, I pocket roughly 14% gain in 6 months. If MFN should close below $10 at the expiration date, I will be forced to own the shares at a cost basis of ~$8.60 ($10 strike - $1.40 premium - commissions). In lieu of any new company disclosures, I find either scenario acceptable.
The other gold miner of interest is Allied Nevada Gold (ANV), which first popped up on my radar when Seth Klarman's Baupost Group disclosed a stake in Q1 2011. Since Klarman is not a noted gold bug so this purchase really piqued my interest. If there was ever an investor that I would piggyback without conducting my own research, it would be Seth Klarman. Even so, I could just not bring myself to pull the trigger on the stock.
Most of the company's resources are currently classified under measured and indicated (M&I), which is more speculative than the proven + probable that I prefer to use as the basis for my investment decision. If Allied Nevada's M&I figures turn out as projected, then ANV is worth considerably more than its current share price. But I have managed to profit and sleep well at night investing in the gold sector the last five years in large part due to adherence to conservative guidelines.
I seriously considered buying ANV around $30 but despite several opportunities to do so in recent months, I still don't own the stock. I just don't feel comfortable betting on the company with M&I resources. But Seth Klarman has vastly superior research access at his disposal so I may yet piggyback on his ANV bet.
Additional disclosure: Short MFN naked put options.