Tom Szabo

Eldorado Gold: A Cost-Effective Way to Move into Gold

Those GORO numbers are all internal projections without the benefit of a detailed, independent mine feasibility study and the company could be in serious violation of SEC regulations for disseminating them to the public. That is probably why they won't think about getting listed on an exchange until after they have been in production for a year -- by that time the internal projections will prove to be either farcical or prescient so there will be no consequence in having to withdraw all of the inappropriate management projections.

Eldorado Gold: A Cost-Effective Way to Move into Gold

The production profile is impressive but with a $4 billion market cap (over $6 billion after Sino Gold acquisition), EGO does not offer compelling value among the mid-tier gold producers according to our comparative valuation model. Our database has about 50 mid-tier gold producers (basically all of them) and considers a number of factors including production rate and growth, cash mining cost, resource size, capital costs, etc. Better positioned rivals include Jaguar Mining and Gammon Gold on NYSE plus New Gold and Great Basin Gold on AMEX. Indeed, only Randgold rates lower than EGO on most metrics. There are also quite a few more attractively mid-tier producers on the TSX and ASX.

Commodities: Brief Correction or Bursting Bubble?

There are quite a few small "commodity stocks" where the project economics are now underwater. If commodity prices slide far enough, the same thing could happen to some of the majors. Over time, the price of a given commodity (absent a monopoly like diamonds) will be slightly higher than the marginal cost of production. This is a reality that most current (sophisticated) investors recognize by awarding P/E ratios that are subpar to the market as a whole. If we do have confirmed peak production in a particular commodity, the paradigm may very well change but this is not something we will be able to confirm until several years of declining production in spite of higher prices. I agree that if and when the mom and pops buy up this sector, there could be other new paradigms to explain the overvaluations. Investing on that basis, however, is an application of the greater fools theory and not the way any billionaire got to be that way. Instead, if you have enough patience to wait for the type of absolute proof that is required to borrow every last penny you can to buy commodity stocks, you might be rewarded in the years ahead. And I don't think it will be too late if you just chill out now and wait for it. Remember the new paradigm: several years of rising commodity prices in spite of declining annual production. If it happens, that would be true alpha.

Leveraging Up on Precious Metals Ahead of Fed Meeting

If the market does not expect the Fed to do anything at Tuesday's meeting, why would confirmation of that put any sort of fire under gold and silver prices, which are at the moment in free fall mode?

The example of copper mining is not quite correct. At 80 cents copper the miners were basically breaking even. Now at $3.00 plus copper they make a margin around $1.50 to $2.00 or more per pound. That is huge and has already propelled many copper miners to multi-bagger gains. It could be the same in reverse on the way down, assuming copper prices collapse as have already lead, zinc, nickel, etc.

We don't see this as much in gold and silver mining because the mentality is somewhat different--the gold miner wants to extend the life of his/her mine as long as possible and therefore will go after lower, previously uneconomic, grades that are now profitable to extract thanks to the higher gold price. This, too, works in reverse, allowing the gold miner to somewhat cushion profit margins. The problem here is not with the gold mine manager's attitude but rather with the gold mine investor's attitude.

Silver Wheaton is a fine company with a great business model but it has risks as well and there are also limits to its leverage to silver prices. With respect to risks, consider that the mines contracted to deliver silver streams are primarily base metal operations (with the exception of Penasquito). If base metal prices fall far enough while silver prices remain high or even rise, these mines may not be profitable and could face shutdown or decreasing production (to conserve cash), thus depriving SLW of silver production. As far as leverage, I recently wrote a comment on a Seeking Alpha piece and don't wish to repeat it here, but suffice it to say that the leverage is something like 70% (ie., if silver prices go up 100%, SLW should go up 170%). Good but certainly not legendary.

What's Wrong With Gold Stocks?

First, spiraling production costs are due to (1) higher energy, equipment and labor costs and (2) miners going after lower grades (even within "first tier" deposits) as justified by the higher gold price. The equipment and labor costs are high in part due to shortages caused by the unprecedented fast pace of new mining activity after a long period of industry contraction. The shortage issues will be resolved in due course. Gold (and silver) prices will continue to outperform inflation (in particular, the rise in energy, labor and equipment costs). This is a plus, not minus, for gold stocks.

Second, ETF demand has not deprived gold stocks of positive investment flow. ETF investors are not reformed gold stock investors fleeing from high risk behavior. Rather, the sheer number of gold stocks and the tremendous amount of financing raised to fund exploration and development have sucked up whatever cash investors have thrown at the sector. Add all the base metal and uranium exploration plays, and you are talking about a huge pile of money that has gone "poof". It takes a while to pay penance for these necessary sins.

Third, as another commenter has pointed out, gold stocks actually thrive in a climate of poor stock market conditions. They actually prefer a bear market in general equities but will get along well if there is just a malaise hanging over Wall Street. History provides plenty of evidence, such as 1929-1936, 1973-1981, 1987 and 1996-7.

So, what's really "wrong" with gold stocks? Nothing. They are just fine, reacting to the ebb and flow of the market and patiently waiting for the next opportunity to dash higher. The wait could be a few more months or even a year or two. But when they next move, it should be a beauty to behold.

Junior Mining Companies Primed for Big Gains

I see no sign that majors are particularly desperate to replace reserves at this point. Before going on a buying spree, they would first start lining up to do JV deals on the best projects, resulting in terms that are very favorable to the junior partners. I'm not seeing that yet. Quite the opposite, the majors are acquiring 50% equity interest in world-class properties by merely providing a portion of the financing and development expertise (think Novagold, Northern Dynasty).

One of the problems is that there aren't that many great projects out there. Juniors put mines into production not by choice but because it is their only choice. Most majors think forward to the next cyclical downturn and wouldn't dare touch some of the "mines" being launched by the juniors these days. If you can tell the difference, you can probably do well buying specific juniors and then waiting for the big fish to bite but otherwise it might make more sense to buy just the majors or at least juniors that are partnered with majors.

If you are buying stocks that appear undervalued to you based solely on "proven ounces in the ground", good luck to you (it will be needed).