Gold Resource: The Biggest Gold Opportunity

| About: Gold Resource (GORO)

Summary

Gold might be entering a bull cycle.

GORO is the best miner among the group.

A 116% return would easily be achieved.

What Is GORO, and where it operates

Gold Resource Corporation (NYSEMKT:GORO), a gold and other metals mining company located in North America, is the smallest among the miners yet the one with the highest growth potential. If 2016-2017 would be the year of gold, then GORO will be the shining star among all the miners, even giving returns higher than gold itself.

GORO has two units in North America, the Oaxaca Mining Unit and the Nevada Mining Unit. The majority of its assets are at the Oaxaca Mining Unit which is located in its Aguila Project, including the Aguila milling facility and Arista underground mine. The Aguila milling facility produces metal concentrates and dore from ore mined from the Arista mine, which contains precious metal products of gold and silver, and by-products of copper, lead, and zinc. GORO performs exploration and evaluation work on its properties within the Nevada Mining Unit.

Why I'm bullish on Gold

Before I continue talking about GORO, I will make a simple analysis giving reasons for being bullish on gold in the 2016-17 horizon.

"Those who don't know history are doomed to repeat it," said Edmund Burke. What's happening in these years reminded me well of what happened before 2007. Easy money was flowing into the economy with ultra-low interest rates. Stocks were at all-time highs with high multiples and unbelievable technology valuations. This time, it's not different except in several cases. In 2007, we all knew that the bubble was in the real estate market, but now we don't know for sure where it is. It may be in the credit card market, in the student loans, or in the energy sector. Carl Icahn, along with several investors known to accurately forecast such macro events, expect that the bubble will pop in the junk bonds market. Nevertheless, corporate levels and earnings are down by 18.5% from their peak, and according to S&P Rating Services, 46 companies in these 4 months defaulted on their debt, the highest level since the financial crisis. The geographical risks cannot be underestimated; China saw its debt levels rise to 225% of GDP. The MENA region faces a similar crisis. This year, Saudi Arabia and China are selling US treasury which means that they know that their economies are in danger. Believe me, I won't stop talking about how the world economy is in danger, and when most investors can see that, gold will be a golden opportunity. You can know more about the dangers facing our economy in this article written by a fellow contributor.

How GORO differs from other miners

To get more leverage for investors who are looking to get advantage of the gold ride, GORO is the most suitable example with a limited downside risk and a huge upside opportunity. I've made a comparison between the biggest gold miners using simple metrics used in valuing gold production.

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Among these miners, GORO is the one with the lowest Equity Value/Sales metrics along with Harmony Resources. However, the latter has lower profit margins with higher debt/capital. GORO, as you can see, carries zero debt risk and a more than average profit margin.

As seen, GORO is among the lowest producers, with about $600 cash cost/ounce which is the lowest among the group, except for Alacer Gold Corp. (OTCPK:ALIAF), which operates its mines in Turkey and other emerging markets carrying higher geopolitical risks.

GORO is one of the companies I personally consider as shareholder friendly. Before Q4 2015, it used to pay a dividend of 12 cents/share (6% yield at that time). GORO has returned $104,000,000 to shareholders since 2010, that is about 66% of its current market value of $150,000,000. And guess what, GORO hasn't made a single equity dilution since about 10 years which results in its outstanding shares remaining at around 55 million shares.

Risks and Rewards of GORO

The problem with GORO is that it depends on only one mine, the Arista Mine. It's currently exploring about 3 mines in Nevada and Mexico. That is why a strike or inability to find a mine with good producing capacity may be a headwind to this company.

In case a labor strike occurred, some calculations are inevitable. The average number of days of a strike is 14 days in the gold sector. Looking at last quarter's numbers, GORO produced about 6,463 ounces of gold, 434,100 ounces of silver, 244 tons of copper, 838 tons of lead and 3,261 tons of zinc. The amount of commodities produced by day (looking only at its major productions of gold and silver) is 71 gold ounces and 4,800 silver ounces per day. (71x14 + 4,800x14) / (440463) = 15% decline in production. So, at a 15% decline in earnings at 18.5 P/E, the stock price would be $2.22. That is a 27% loss from these levels, assuming the investor sold when the strike was announced and didn't wait for a price recovery.

On the other hand, if gold prices reached $1,400 (which is highly possible in this tense environment), earnings will increase by 16% and a P/E of 35 since the market gives an approximate of that number in a bullish market, or even more. Since GORO is a small producer with a huge growth potential, the price of GORO would be a minimum of $6.5, which is an about 116% upside. (The price of the stock reached $25 at the peak of the gold bullish cycle in 2012).

Another scenario which might give a high return is the probability of GORO being acquired at a high premium price relative to its strong financial position with no debt burden and low cash cost per ounce of just $551 (Q1 2016 nb.). This, of course, is only about the cash costs which are the costs related to the production process only, not including head office costs and interest expense which are ultra low for GORO and extremely high for other producers which have a high debt and give high salaries.

My calculations show that GORO's risk of having one producing mine is eliminated

According to the 2015 10-K, the Arista mine still has proven reserves of the following:

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If one looks at the gold and silver ounces proven reserves, and takes a 60% chance that the probable reserves are proven, then the total proven reserves of the mine is 110,000 gold ounces and about 8,000,000 silver ounces (I disregarded copper, lead and zinc due to relative low priority to gold and silver). At Q1 2016, GORO mined about 6,500 gold ounces and 430,000 silver ounces. At this rate, the Arista mine will be totally finished in a maximum of 4.5 years (assuming the production capacity stays constant). To be conservative, let us take 3.5 years as a mine life of the Aristas. I also didn't take into account the mineralized materials that do not constitute under "reserves" in the U.S reporting requirements since they are about 33,000 gold ounces and 2,200,000 silver ounces under the switchback only. 3.5 years are enough for the company to take one of the other mines in Nevada into production. The Altra Gracia property is personally the best choice due to its high G/T which is about the same as the Arista mine.

Conclusion

GORO is a small producer with no long-term debt and a relatively strong cash flow and a huge upside potential. I personally like stocks which carry very low debt and having a low valuation of EV/Sales giving it a lower risk than other competitors. GORO is one of the companies I have on my top 10 lists. Bank of America (NYSE:BAC) and Netflix (NASDAQ:NFLX) are on that list too. I'm looking to provide you with a detailed analysis of Netflix soon.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GORO over 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.