Investing Like Buffett: Why NovaGold is a Buy

Warren Buffet is a great investor. That's a bit of an understatement. He's probably one of the greatest investors that has ever lived and his exceptional performance will continue by huge nominal numbers until he dies.

His percentage returns will drop, however, because of the sheer size of his empire. Imagine trying to earn 20+% returns on a behemoth like Berkshire Hathaway. It's nearly impossible and Buffet himself has warned investors that he cannot replicate his past performance going forward due to the limited scope of worthwhile investment opportunities that Berkshire can pursue. Go ahead and read his latest shareholder letters and read it yourself.

Case in point, even if Buffet discovered an absolutely stellar company selling for book value of $100 million and he was absolutely positive he could earn $50 million net with the company's business. $50 million to the bottom-line of a company the size of Berkshire Hathaway is a drop in the bucket.

Our Advantage

This is where being a 'little guy' has it's advantages. As a small time investor your investment universe is not limited to billion dollar companies. And if you play it smart you can establish high rates of returns on what other's may see as the most speculative and 'risky' investments and minimize your downside.

The Strategy

One of the key points that Warren Buffet stresses in his investments is margin of safety. This, of course, is a concept that Benjamin Graham, his mentor, took great deals to emphasize in his book Security Analysis.

So how do we take the concept of margin of safety and apply it to a junior mining companies which most likely does not have any cash flow and any planned mined developements are years in the future with high up-front costs which are subject to heavy stock dilution and hedge risk.

I'll be the first to admit that becoming an expert in junior resource investing is more art than science. There are very few metrics to scientifically formulate a risk profile. Some stocks will jump hundreds of percent in one day and some will lose half their value just as fast. It's no surprise then that most investors who stumble into this sector will lose all or most of their money and wimper away with their tail between their legs. This is not a sector for the faint of heart.

So, back to my point, how do you buffer in a margin of safety into your investments? The answer to that is price. The price you pay for the stock you want. That's the only thing you can control. The higher the price is for the stock you buy (given it's "value", which is entirely subjective) the higher your risk for loss of capital.

Controlling the price you pay for a stock is obviously a lot easier said than done. But those who are able to control their emotions and pay reasonable prices for exceptional companies have a COMPETITIVE ADVANTAGE in this game.

So this all brings me to my next recommendation. Nova Gold.

I first bought Nova Gold back in 2003 for about $3.96. Ever since then I've been upset at myself for not establishing a larger position. It went on a tear for the next few years to a high of $20.44 in 2007. Then recently due to some issues over cost estimation over-runs at its Galore Creek property and subsequent halt of mine development plans, the stock tanked. I'm absolutely elated over this development. This is a classic example 'fear' overtaking the markets. Just like Buffet says, don't buy a stock unless you'd be happy to see it's price fall in half.

You can see from the chart for yourself. It's been a wild ride.

click to enlarge image

So let's do a quick back of the envelope margin of safety analysis on Novagold to determine if it's a worthwhile investment at current prices.

Novagold has four main projects at various stages of developement and ownership. They are as follows:

Donlin Creek

• 31.7M ozs Gold M&I 4.2M ozs Gold Inferred
• NovaGold owns 50%

Nome Operations

• 0.5M ozs Gold Reserves
• 1.8M ozs Gold M&I
• 0.3M ozs Gold Inferred
• NovaGold owns 100%

Galore Creek

• 8.9B lbs Copper M&I
• 7.3M ozs Gold M&I
• 123M ozs Silver M&I
• 3.6B lbs Copper Inf
• 3.8M ozs Gold Inf
• 65M ozs Silver Inf
• NovaGold owns 50%

Ambler

• 1.5B lbs Copper Indicated
• 2.2B lbs Zinc Indicated
• 0.5M ozs Gold Indicated
• 32.3M ozs Silver Indicated
• 0.9B lbs Copper Inferred
• 1.3B lbs Zinc Inferred
• 0.3M ozs Gold Inferred
• 18.6M ozs Silver Inferred
• NovaGold earning 51% interest

For the sake of this analysis just to demonstrate how large of a margin of safety I'm going to use, I'm going to value Novagold's stake in the Nome Operations, Galore Creek and Ambler projects at absolutely ZERO. I give no credit to Novagold for them, which is absolutely ridiculous considering their track record for discovery.

So based just on the Donlin Creek Resource of 31.7 million ozs measured & indicated plus 4.2 million inferred ounces of gold of which Novagold owns 50%, I come up with a figure of 17.95 million gold ounces attributable to Novagold. Let's value just 10% of that, which gives 1.795 million ounces at today's closing gold price of $917.25, which gives a value of approximately $1.6 billion.

Novagold has a fully diluted share structure of 117.2 million, which values the entire company at $879 million (Canadian dollars). So the entire company is being valued for almost half of my ridiculous valuation of just 10% of the in-situ value of JUST ONE of their projects giving absolutely no credit to their 3 other main projects, not to mention their other exploration properties.

Bear in mind that the going concern, and the reason for the precipitious fall in the share price is the uncertainty over the cost of bringing these assets into production. I have no doubts that this project will eventually become a mine. Anything with a defined resource of over 30 million ounces of gold, (which by the way has an in-situ-value of over $27 billion at todays gold prices!) will be mined by somebody. Especially in this environment of major producers scrambling to replace fast depleting ore reserves. The gold price will only continue to climb and everyday the in-situ value will grow and make the project more and more enticing and feasible.

Disclosure: Based on this rather crude, but in my opinion, safe analysis I'm putting Novagold on the official Calvin's Pick list as a BUY at todays closing price of $7.50 CAD. These are fire-sale prices that will not last much longer.

Comments

[jimmy46:]

And the world's oceans have millions of tons of gold,
but what would it cost to extract that???

You say nothing about costs, WHAT WOULD IT COST?

2008 Jun 27 03:39 PM

[Reinhard:]

Well, he is basically saying that by assuming only 10% of the entire resource. So the remaining 90% have to cover the cost, the real opportunity cost of our capital, and whatever is not mined. Sounds not too far off. They should be able to squeeze out profits of a few hundred dollars per ounce of gold. Hopefully.

2008 Jun 27 06:30 PM

[Calvin Oh:]

I don't know what it would cost. That is the concern that caused the precipitous decline in the stock price. This uncertainty is an opportunity for investors who have been wanting to establish a position or accumulate.

There were previous estimates that the costs to build a mine would be in the $2 billion area but now estimates are $4 billion plus. The exact numbers, I don't know since I am not a mine engineer. The pre-feasibility is due in Q-1 of 2009. We'll have a clearer picture when the study is released. If you're waiting for all the risk to be gone before taking a stab at NG then you should wait until the stock goes back above $20 or steer clear of the junior mining sector all together.

The costs to extract gold out of the world's oceans would be approximately $35,876 per gram.

2008 Jun 27 06:39 PM

[Calvin Oh:]

Keep in mind also, that Barrick is the other 50% partner on the project, which gives the project a higher probability of becoming a mine, because of the expertise in mine building and financial capacity that Barrick brings to the table.

2008 Jun 27 06:44 PM

[Mongoose:]

No guts , No Glory

2008 Jun 27 09:08 PM

[ussmls7:]

Barricks Who?? are they really?Do You Konw?

2008 Jun 29 02:52 AM

[bruin532:]

The better paces than NG to loose money.

2008 Jun 29 03:48 PM

[Benjamin Gr...:]

I am spinning in my grave. Please do not invoke my name in a pump-and-dump scam!

2008 Jun 30 09:47 AM

[Tom Szabo:]

You are underestimating the environmental issues, which won't go away very quickly. Projects the size of Donlin or Galore Creek face enormous challenges--especially with litigation appeals being heard in San Francisco at the U.S. 9th District court. The $2 billion+ cost overrun at Galore was partially due to the fact they couldn't use a nearby valley for tailings as envisioned because there wasn't enough space to turn the trucks around. That assumes tailings impoundment would have even been approved there. I think Northern Dynasty at one point planned to dump waste rock straight into the ocean at Pebble. Fat chance. These projects may yet go into production, but environmental compliance costs are going to be massive. I wouldn't assign anywhere near 10% in situ if Donlin was a normal deposit, but in fact it is extraordinary and probably deserves 20%. The problem is, the environmental haircut is like 80% (20% of 20% is only 4%). The key to higher price is to reduce that environmental haircut.

2008 Jul 04 07:48 AM