Midway Gold: Is This Junior Miner Worth Its Weight?

Includes: ABX, GDXJ, MDW
by: Daniel Fridson

A reader recently asked me about Midway Gold, so I thought I'd give a quick overview of the stock and my outlook on junior gold miners in general.

I invested in Midway gold (NYSEMKT:MDW) stock, thinking that its slide had ended and that it would be shooting back up to $1.40 for a quick gain. Instead, I bought it at $1.19, and almost immediately it started to go down, down, down. It's now at $1.10, and was flirting with dropping below its 52 week low of $1.07 yesterday. Is there any reason stocks like this one drop on heavy volume with no news reports? That stuff gets me nervous. All of the indicators tell me this is a good stock, run by people who know gold and silver mining. My worries are 1) That Barrick Gold would pull the rug from under Spring Valley project, and 2) That permit issues could plague their Pan project.



Right off the bat, I should let you know that I'm not a licensed financial advisor, but I'm happy to talk about Midway's recent performance, its future prospects and what approaches one might take to evaluate them. There are a lot of promising mid-cap miners out there, and it's very helpful to figure out which ones are drawing active interest from readers here on Seeking Alpha.

It should be noted that since Doug contacted me, Midway is back up to $1.37, right around where Doug had pegged it, the spike coinciding with the encouraging drill results from its PAN Gold Project in Nevada. To give a little background on the stock, Midway peaked in January of 2008 at $4.38 per share before freefalling down to 15 cents in October of the same year. Despite sagging market confidence, Barrick Gold (NYSE:ABX), which had been an equity investor in Midway since 2006, finalized joint venture agreements with Midway on the aforementioned projects in Spring Valley in 2008 and Pan in 2009.

During the gold boom of 2011, the stock climbed once again, only to backslide on disappointing drill results, which were preceded by some insider selling on the part of then-CEO Daniel Wolfus. As for the recent performance to which Doug alludes, he presumably bought the stock at $1.19 around the beginning of August. A quick cross-reference of the stock chart and news headlines shows that the dip he experienced coincided with Midway's Q2 financial results announcement on August 7. It would seem that investors were not confident that the increase in operating and financing costs were justified by the existing drill results, a perception which changed with the most recent geometric data.

In general, the moves in a pre-production miner's stock are largely based on drill results and the market's ensuing interpretation. Financial results obviously have an impact as well, but only in the context of the valuation of its mines. While larger mining stocks with sophisticated capital structures warrant traditional fundamental analysis, many analysts prefer to look at miners through the prism of Net Asset Value, which considers the combined discounted present value of a company's existing mineral properties, working capital, value of other investments, and value of its hedge book, less liabilities. Junior miners are not likely to have significant investments in trading securities or in derivatives, so the valuation is largely dependent on the mineral properties.

Keep in mind that many mining companies list in Canada, whose accounting laws allow a write-up of mineral resources without proving that they can be economically extracted. American-listed companies such as Midway do not face this problem, but be careful not to simply ascribe the value of minerals listed on a Canadian balance sheet in an NAV analysis and pay close attention to the estimated costs, which are likely contained in the NI 43-101.

As for Doug's specific concerns on Midway, whether Barrick is going to pull the plug or not is a function of the value of the project, and Barricks's historic willingness to pour money into it. I have not done specific due diligence on this aspect of the company, but Doug is right to look at the soundness of the partnership. In general, Barrick has seemingly stuck by Midway's projects through thick and thin.

As for permitting at Pan, this is a concern that must be factored into all mining properties, especially those in America. As American Manganese CEO Larry Reaugh reminded me in a recent interview, America has the second longest mine permitting process in the world after Indonesia. For purposes of analysis, this puts U.S. mines at a higher discount premium than one might expect for a stable first-world country. Unfortunately, permitting processes are often difficult to predict, even right here at home.

The best you can do, generally, is to look at the history of mining companies in the area and compare them to current developments. In the case of Nevada, mining is highly important to the state's economy. Seeking Alpha's Troy Bayer interviewed a mining executive on this topic, last week, who made the very salient point that Nevada faces the highest unemployment rate in the U.S., and that the mining sector provides an average salary twice that of the average Nevada employee. There will likely be political incentives to make sure the project continues. One can also consider that HR 4402, The National Strategic and Critical Minerals Production Act of 2012, was introduced by a Nevada representative before it passed the House. It has predictably stalled in the more Democratic Senate, but keep an eye on the senatorial elections in 2012. A strong Republican victory could make the bill more likely to be signed into law.

As for the future of Midway Gold, it depends to a large degree on the future of gold prices and the prospect of future Quantitative Easing on the part of the Fed. Many analysts have been frustrated over the past couple of years, as any combined macro/balance sheet analysis shows that gold miners are undervalued, considering the prospect of rising gold prices and economic and currency concerns across the globe. Most intrinsic value calculations on precious metals stocks last year showed a huge upside, yet many industry majors failed to catch up with the runaway rise in commodity prices.

However, just because gold euphoria has subsided a bit does not dampen the long-term upside of its miners' shares. In my analysis last year of companies such as Barrick and African Barrick, it seemed miners were undervalued, even as I was slightly less bullish on the gold rush than many of my peers. By my calculations, even a relatively flat forward gold price should have dictated a higher share price than the trading levels around that time.

However, the trend may be reversing: "We think valuation disconnects relative to bullion as well as higher dividend payments could help gold mining equities regain some ground," said Morningstar's Joung Park last week, echoing thoughts of many analysts over the past year. However, Park said this in the context of Gold Miner ETFs beginning to close the gap. As noted in the article, several of them have been outperforming bullion indices over the past three months. Midway is represented in the Market Vectors Junior Gold Miners Index (NYSEARCA:GDXJ), which the article mentions is up about 8% over the past three months.

Whether one wants to capitalize on these new developments by investing in ETFs or individual equities depends on your portfolio strategy and risk tolerance, but Midway certainly warrants a good look, given its strategic partnership with Barrick and recently encouraging drill results.

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. I have no business relationship with any company whose stock is mentioned in this article.