Gold Stocks Are Dead. Long Live Gold Stocks!

by: Derek Blain

Gold stocks - there's not a whole lot of love towards the producers and royalty earners on the yellow metal these days. Investors have watched in dismay as calls for hyperinflation have repeatedly reached fever pitch, waiting for the era where gold truly "shines," and repeatedly seen not only the metal or its synthetic representatives (i.e. GLD), but those who find it, assay it, dig it up, and refine it continue to lose value.

While I don't believe that a great portion of the gold mining sector is cheap relative to their assets and income, there are some attractive plays out there that have been dragged down alongside their more overvalued counterparts, and I would like to cover why now might be a good time to start looking at a long-term entry (with that extra capital you have no doubt sold, in a most timely manner, by relieving yourself of the latest hype stocks trading at stratospheric elevations relative to the reality of their businesses. Ahem-azon.)

Gold Stock Bugs Have Been Squashed

Gold stocks are down relative to their respective element, and down hard. While gold itself is down by a mere 13%, the HUI has bled off 38% from its high in September 2011, almost triple the losses of the price of the yellow metal they seek. This is exceedingly frustrating in the face of the usual culprits for gold bugs ongoing to-$5000-tomorrow story - QE programs have expanded to literally ridiculous portions of the overall bond market, leverage is at pre-crisis levels, money stock is at all-time high levels. People should be rushing to their metal dealers and buying gold stocks hand over fist, right? What gives?

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Unfortunately for gold bugs, gold and gold stocks are still treated as financial assets. My sneaking suspicion is that gold is slowly and surely being re-adopted as a monetary medium behind the scenes (see: The huge increases in Chinese and Russian buying, German repatriation, and drastically increased participation and total holdings in gold financial instruments). That being said, it is still subject to the same psychological forces that all other financial assets are subject to - human beings, operating with limited information, tend to herd in probabilistic psychological patterns of optimism and pessimism (see my write-up on this, by clicking here). This leaves gold stock investors scratching their heads and watching the prices of gold stocks move back to levels seen as far back as late June, 2009.

To further add to the mess, we have seen production costs continue to increase every single year while the price of gold has ground sideways and down. The average production cost per ounce of gold for the top three companies in the Market Vectors Gold Miners ETF (GDX) component is as follows:



All-in cost/oz of Gold
2012 / 2013


Forward P/E

Barrick Gold


$945 / $1000-$1100





$865 / $1000-$1100



Newmont Mining


$ / $1100 - $1200



Source: Annual Reports and Guidance for Q4 2012

I wouldn't call the majors, other than Barrick (and that's iffy), affordable (it is trading at about a 27% premium to its book value). And even then, there are better options for shareholders looking for deep value plays. I will discuss them ahead. Avoid the big names and check out some of the more obscure, heavily discounted plays before gold prices find a bottom and broader interest in gold equities resumes.

Overlooked Value in a Small Corner of the Gold Market

We've Been Down This Road Once Before - I Recommend A Second Trip

I have already written about this company in the past, and recommended it when it was trading at $1.20/share. It has a small run up to the $1.50 mark and has since began a corrective phase - an optimal time to get in while most people don't even know that this company exists. For a detailed write up on Dynacor Gold Mines (OTCPK:DNGDF), a one-of-a-kind, self-funding ore processor-turned-explorer that is anticipated to release initial results of its drilling project at its flagship Tumipampa property sometime within the next several weeks, click here.

Dale over at Dynacor is one of the most amicable folks I have been in touch with as an investor, bar none. He can be contacted with specific questions, here.

This One's For The Cheapskates

Nevsun Resources (NYSEMKT:NSU) is cheaper than sand, when you consider its future earnings against pretty much any peer it has. It has seen less than two years of revenue, and is therefore completely off of the radar for most people. It already pays a decent dividend of 2.53% annually. It is currently producing gold, but it has a very unique open pit reserve that will actually transition through several minerals. It will switch to majority copper production sometime in mid-2013. Production for 2012 was 300koz of gold, and is estimated at 80koz of gold for 2013, plus 60-80 million pounds of copper. It is expecting strong copper production for several years, as well as zinc, and will eventually add silver to the mine's output.

Value-wise, it's a steal. It currently trades at a mere 5.5% premium to its net tangible book value, something that very few producing, cash flow generating assets can possibly claim in today's current climate - even many miners are trading at 1.5-2x net book and sometimes far higher than that. This company has seen share prices pop up as high as 10x book value before, so upside potential is very considerable. Think of this - Nevsun is trading at the same price-to-book as it was at the bottom of the gold market in the fall of 2008 - it is now producing, generating gobs of cash flow relative to its market cap, and pays a nice dividend for a miner.

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It is trading at an extremely low 4.63 P/E and a 5.40 forward P/E, due to the transition. Long-term analyst forecasts that have pegged its future cash flow are predicting a $2.75/lb copper price for the next few years, which is a far cry below current price levels.

Downsides to this company are that you are essentially 100% exposed to geopolitical risk. The mine is located in Eritrea, East Africa. Were something unexpected to happen there and operations shut down, there are no supplemental mines running to keep the company afloat. Something to keep in mind.

The transitional phase between gold and copper has pretty much been completed and is on schedule, but there could still be a small risk of delays in the last 20% of the project. Once that uncertainty is out of the way, expect the share price to resume building off of the double bottom low it established last year, when it popped from $2.70 a share all the way up to $4.98. It currently trades just below $4.00 per share. Keep in mind - Nevsun has $1.63 per share in net cash and almost no debt.

I encourage you to have a look at Nevsun's corporate presentation and fact sheets for more information. Shareholder relations are also prospective-investor-friendly, and be contacted here.

I recommend purchasing Nevsun while it is still below $4.00/share, roughly at the value of its tangible assets, including a pile of cash. A continued sell-off in gold and copper, which looks very likely for the short term, should add some downside pressure to this stock that can present a great buying opportunity on weakness. It could carry all the way through to a swift new low below $2.78, but internals are already diverged well onto the upside, so if it does, it is the final low for the entire move. I recommend a moderate position around current levels, and cost dollar averaging into it if the price continues to track gold - A break above (although it is diverging up already, against gold, and has begun to more closely track the copper price) its recent high indicates the uptrend is still intact, and future appreciation can be expected.

A Diversified, Geographically Safe Producer At A Steep Discount

Alacer Gold (ASR on the TSX, OTCPK:ALIAF on the OTC) just completed a significant sale of its Frog Leg operation to La Mancha Resources (OTC:LACHF). It raised $171 million in cash and shares, including a special dividend payout to shareholders, moving it further along in its stated 2013 operational goals of increasing free cash flow, focusing on higher yield projects with better reserves, and slimming the company down to maximize shareholder returns. It is still holding onto its flagship, high-grade and high-yielding project in Turkey, the Copler mine, while taking advantage of its partnerships and selling off less productive assets.

This should land Alacer shareholders in a superior long-term position - they will own a company who is still directly profiting from its old projects via the equity positions its asset sales have allowed it to accumulate, but they retain the highest yielding, highest margin project under their own roof after going through efficiency maximizing processes on their own operation.

Copler is currently undergoing a feasibility study to assess mining their sulfide ore at Copler, a reserve that is expected to contain gold content of over 2 million ounces. The current reserves of the mine are 4.4 moz of gold, so this would increase proven reserves by almost 50% on an already established project with the bulk of the capex already invested. I believe this will be a long term deep value for shareholders. A full presentation on Copler can be found here.

I like Alacer because they are trading at a steep discount to their book value right now. Alacer had just over $1.925 billion in tangible assets as of Q3 2012, with only $375 million in total liabilities, leaving shareholders with a net equity position of over $1.55 billion. Its current share price puts it at a market cap of $950 million, which means that shareholders buying around current levels are getting the assets on sale to the tune of 39%, and that's not including the 2m oz addition to the Copler mine, or the fact that the heavily discounted future cash flow of its Frog Leg project in Australia has now translated into $171 million of current position cash and equity to be invested in more profitable operations. Their secondary operation, the Higginsville mine, is expected to yield at least 5 years more production, and offers a fairly high yield cash flow (production was 175,000 oz in 2011).

A word of caution - Alacer's stock has been falling like a rock over the past few days, getting a hammered to the tune of 25%+. The long-term internals are diverging, finally, off of its corrective downtrend from the late 2011 highs at $12.66/share. We could see this corrective move take it all the way down to previous support at $2.20/share. I recommend averaging in if the stock continues to move to the downside, building a long-term position on a mining operation that is expected to yield.

Long Live Gold Stocks!

These smaller mining stocks have acted in a leading capacity - diverging early-upward against a general trend down in gold stocks and gold itself. This tells the observer something: the early market players likely see some serious future value here that the broad market, and even the broad gold community, are mostly ignoring.

If a gold company cannot produce a high rate of return on a price of $1700/oz of the yellow metal, then an investor should move on. I think a more likely long term, conservative gold price will put it somewhere in the realm of $1,000 - $1,300/oz, meaning that most of the majors will require huge overhauls and have to sell off under-performing or losing assets at a steep discount. Unfortunately, most major producers have been racking up a lot of debt over the past decade, and the bull market trend has allowed them to gravitate toward reserves that may not have ended up being a wise investment if gold continues to stay range-bound or slowly fall off over the next several years.

As such, I think a wiser approach in future is to find gold stocks whose management are producing superior internal returns for shareholders (a dividend with potential payout growth doesn't hurt), as opposed to strictly using the traditional cash-cost/all-in-cost methodology (which shows that further downside will seriously hurt many mining operations). If we start treating gold stocks as a special asset all of their own, as opposed to businesses creating a product (even money itself is a product) for their customers, that is a good time stop and say "no, this is just a business - and not a very good one, at that. Trying to find very rare stuff, dig it out efficiently, isolate it, purify it, and then put it all back together again." Mining is a tough gig, so instead of saying "well, inflation is obviously inevitable and therefore gold is obviously going up" (and ignoring the entire 1980's, 1990's, 1960's, 1950's, and 1920's decades, for the record), we should be looking at every miner as a product-producing business, and evaluate it on its merits within that context. As such, I think these three picks are all excellent candidates for value, growth potential, and superior investor returns over time.


As with most major trends, we will likely see the most debt-laden producers and late-stage explorers get hit the hardest as they have to restructure their operations to accommodate a trend that is no longer perpetually bullish, or harm existing shareholders with continued dilution. Small caps are the name of the game going forward, as they tend to bottom near the majors in sector crunches, but lead to the upside because they are more nimble and can adjust more easily.

A word of caution, though - many small cap miners have operations that are just not sustainable if gold takes another leg down below $1500, and this could be the harbinger of many nasty surprises for shareholders, including indefinitely canceled projects and major setbacks. You have to be very picky and choosy, looking strictly beyond cash-cost, all-in-cost, versus the existing gold price, looking beyond "oh, wow, these guys have a really big reserve sitting in the ground." I can't tell you how many tiny little gold story stocks have provided excellent salaries for the management team over the past five years while bleeding and diluting shareholders dry.

We are late in the downtrend in overall gold stocks, and now is the time to pick between future winners that have been tossed out with the future laggards. Take advantage of the pessimism that spans almost the entire gold mining sector and lock in some cheap producing assets for the long term.

Disclosure: I am long OTCPK:DNGDF, NSU, OTCPK:ALIAF. 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. I am long both Dynacor and Alacer gold on the TSX shares, under the symbols, and, respectively.