Time To Pick Up The Gold Miners

 |  Includes: AEM, AU, AUY, EGO, GDX, GDXJ, GG, GLD, NUGT
by: Christopher F. Davis

One of the most battered, hated sectors of the last 6 months has been mining and metals, particularly the gold miners. This of course is in large part due to the falling price of gold. Gold prices slipped in July only to rebound in the last few days alone on increased QE3 likelihood, and possible European stimulus. Gold prices are down almost 8% from their march highs, and down nearly 30% from the highs of last year. The Gold ETF (GLD) is nearly flat on the year and also down in similar fashion with gold. In the past, the gold miners have seemed to trail the price of gold, with a general expectation was that the mining stocks could potentially catch up to the move in gold prices. However, with gold now back above $1,600 an ounce, the miners are starting to look like a strong buy in my opinion.

Before highlighting reasons why the miners are good investments at this point, its important to recognize the macro headwinds for the miners that do exist. Large gold deposits that are easily extractable are rare. To sustain growth, the world's top miners are building huge multi-billion-dollar mines in remote regions of the globe. Building a mine where there is no infrastructure is not cheap, and labor and material costs have risen along with metal prices. Even the slightest delay can wreak havoc on a mine's development budget. The bigger the project, "the more likely are the problems, whether technical, political or community-related", said Morningstar mining analyst Joung Park. Environmentalists can also be a headwind for any new or large mining project, as mining operations, even carefully conducted, can pollute surrounding ecosystems. Labor costs are perhaps one of the largest headwinds across the board for these companies, and is one that is not readily reducible without sacrificing quality of the employee. This problem of labor costs was cited by Goldcorp (GG) CEO Chuck Jinesse in a recent CNBC interview. There are, however, some positives for the industry.

Some tailwinds for the company include falling prices of crude oil over the past few months which should lead to lower extraction costs as oil is a major input price in mining costs. Further, as alluded to above, there seems to be a strong likelihood of another round of easing from the Federal Reserve, or so called QE3, after another weak GDP report (though it was slightly better than expected). This has sent the price of gold up 50 bucks an ounce in the last few trading days. Further, the European Central Bank head Mario Draghi has stated that they are prepared to do all they can to preserve the Euro, and it seems German Chancellor Angela Merkel is on board with plans to "protect" the eurozone, after months of playing proverbial hardball. The mostly likely way the ECB would stimulate is their own easing in the eurozone through printing of money and bond buying. This is a major inflationary pressure, which in turn is a major tailwind for gold. Further, we are also on the verge of entering a seasonally strong period for the yellow metal. Specifically, late August and September followed by November to January, being some of the historically best months for gold, and in turn, for the miners.

For the past few years, the miners have been chasing the metal. The surmised expectation was that the mining stocks would eventually catch up to gold prices. Now may be the time, as the miners are starting to look like a value play in my opinion. As it stands now, I think some of the gold mining ETFs such as the Gold Miners ETF (GDX), the Junior Gold Miners ETF (GDXJ) and Direxion Daily Gold Miners Bull 3X ETF (NUGT) are the best way to catch a bounce in these stocks. However, the individual companies could make you money as well, as guidance has been lowered by most of these companies to more reasonable levels. Even if gold stays within a $1,525 per oz to $1,650 per oz, I believe the miners will bounce, however the gains will be at a faster rate should easing policies go through.

The following companies, in my opinion, are the best way to play the miners:

Goldcorp: At current share price levels of $36.25, and after having lowered their guidance for the remainder of the year, this stock may have found its bottom as the company moves ahead. The numbers for this company in Q2, and for most miners, were disappointing. GG reported a drop in second quarter profits and earlier this month the company lowered its 2012 production guidance. Profit dropped to $268 million, or 26 cents a share, in the quarter ended June 30, from $489 million, or 52 cents, a year earlier. Removing one-time items, profit dropped to $332 million, or 41 cents a share, from $413 million, or 52 cents. Analysts, on average, had expected earnings of 42 cents a share. And revenue fell to $1.1 billion in the second quarter from $1.3 billion on lower gold output and sales. The quarter was a disappointment, and is about 5 points off of its all time lows last week. However, they have a world class gold mining operation, and have the capacity to buy out smaller companies with proven reserves. I see the stock as a buy.

Agnico-Eagle Mines (AEM): AEM actually was one of the better miners in Q2. Their solid quarter is a reason that AEM is trading at a three month high of $43.16. AEM reported quarterly net income of $43.3 million, or 25 cents per share, for the second quarter of 2012.These results include a loss (mainly impairment) on available-for-sale securities of $18.3 million, or 11 cents per share, stock option expense of $7.8 million, or 5 cents per share, a non-recurring tax loss of $4.3 million, or 3 cents per share, and other non-recurring expenses of $6.2 million or 4 cents per share. These items were dampened by a non cash foreign currency translation gain of $11.0 million, or 6 cents per share. Excluding these items would yield an adjusted net income of $68.9 million, or 40 cents per share. In the second quarter of 2011, AEM reported net income of $68.8 million, or 41 cents per share. Cash flow was strong as Q2 cash provided by operating activities was $194.1 million ($142.0 million before changes in non cash parts of working capital). This is up over 15% up from cash provided by operating activities of $162.8 million in the second quarter of 2011 ($161.7 million before changes in non-cash components of working capital). This stock represents one of the premier miners in the space and is another buy.

Eldorado Gold (EGO): EGO has been battered over the last few months, along with the entire mining sector. EGO had an awful Q2 result, but much like GG, I think the bottom is in. First, the Q2 numbers. Eldorado on Friday reported net income of $46.6 million, or 7 cents per share. That compared with net income of $74.9 million, or 14 cents per share, a year ago. Overall revenue fell about 3% to $244.2 million from $252.6 million. Gold sales also dropped, although the average price rose to $1,612 per ounce from $1,510 per ounce. Gold production fell 13%, while average cash operating costs rose to $480 per ounce from $397 per ounce. Eldorado reduced its 2012 forecast to 660,000 ounces of gold at average cash operating costs of $465 per ounce because of a treatment plant delay at a mine in Turkey and a delay in permitting for a mine under construction in China. That compares with the previous full-year guidance of 730,000 ounces to 775,000 ounces and cash operating costs in a range between $430 per ounce and $450 per ounce. In the longer term, EGO recently acquired European Goldfields. This has increased their production potential over the next few years significantly. They also are making progress in mines in Greece and China which should lead to increased production. Like GG, I think this stock has found its bottom, and could be bought at these levels.

Yamana Gold (AUY): AUY reports Q2 results on August 5th. Analysts expect on average 24 cents a share. For the year they expect to see AUY post $1.07 earnings. Their Q1 results came in with a 1 cent miss, reporting 25 cents versus estimated 26 cents. Given the quarters ABX, EGO, and GG it could be a miss. However, things are looking strong for Yamana. plans to start up two more mines this year, with a third going into production in 2013, adding up to about 400,000 ounces of new output between 2011 and 2014 at a total capital cost below $1 billion. AUY recently received some positive analyst comments. Analysts at HSBC upgraded AUY from a neutral rating to an overweight rating in a report issued on Thursday July 26th. Analysts at Credit Suisse raised their price target on shares of AUY to $22.00 in a research note to investors on Thursday, June 7th and they also have an outperform rating on AUY. The stock is trading at 15.24, approximately in the middle of its 52 week range.

AngloGold Ashanti (AU): AU has an average price target of $48 a share, with HSBC looking for a $71 price on the stock. AU reports on August 6th, but it may be a strong quarter. AU preannounced gold production of 1.073 million oz, which represents a 9% improvement Q1, at an estimated total cash cost of $800 per oz. This is superior than what the guidance was for the quarter of 1.04 million oz at a total cash cost of $840 per oz. This is in part due to the African and American mining operations. Gold production from South African operations improved over the period, and was 18% higher than the 2012 Q1. Adjusted headline earnings for the quarter are estimated at between $240 to $255 million. When compared with 2012 Q1, exploration and other expenditures were higher, though in line with annual guidance provided in February. All this after a lower average gold price received during the quarter compared to the previous quarter. I think it's a strong buy right here.

Other Gold Miners that I think are worth doing homework on as possible investments:

Rangold Resources (GOLD)

New Gold (NGD)

Harmony Gold Mining (HMY)

Royal Gold (RGLD)


For more speculative longer term investments:

NovaGold (NG): See why NovaGold may be a long-term buy at these levels

Kinross Gold Corp (KGC)

Seabridge Gold (SA)

These mining stocks are on sale. They make a great addition to most portfolios, particularly for gold exposure. If you want general exposure to the sector as a whole in lieu of a single stock, then I recommend the three possible ETF plays above. These were the gold mining etf , the junior gold mining etf , and the Direxion Daily Gold Miner Bull 3x ETF . Call options activity has been heavy on the mining etfs suggesting a bullish move in these etfs. I like playing NUGT, as it will deliver outrageous returns in the next few weeks or months should the mining space as a whole moves up. NUGT just touched a 52 week low of 7.70. It is now trading at $9.57, which is very low for its historic levels. Just 6 months ago it was at $27 a share, representing a 300% gain from these levels should the mining space move in the next few months.

Should the price of gold languish, the miners may be stuck at these levels for a few months, yet I believe there is not much downside left, and the risk, justifies the reward. Do your portfolio a favor and "pick" up a gold miner.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NUGT over the next 72 hours.