As 2015 nears it seems intuitive to come up with watch lists and buy lists, and with the gold price trying to make a bottom I think a lot of investors want to know which gold miners are worth buying. Yet in trying to make a list and looking at valuations, I came to the realization that while I have favorites in the sector there are so many names that are compelling right now, as valuations have collapsed nearly 50% since this summer. So while I may come up with such a list in the next few days I wanted to start out with a list of gold miners that I think investors should avoid.
I think with several names investors have misconceptions regarding how much it costs them to pull an ounce of gold out of the ground, or even that they will actually produce any gold going forward. People like to claim that their favorite names have low-cost production and that this production is growing when there is hardly any substantial in these claims. As a result, we've seen some fairly extreme valuations and market inefficiencies.
So, I've created the following list of gold miners I think investors should avoid in 2015.
1. New Gold (NYSEMKT:NGD)
New Gold exemplifies precisely what I was just saying. Investors believe that this is a low-cost producer with growth. That simply isn't true.
The Low-Cost Myth
New Gold has four mines -- three of which are relatively high cost producers. The fourth -- New Afton -- is a copper mine with some gold production, although New Gold likes to call it a gold mine with copper offsets. The copper offsets get production costs to some ridiculous figure such as $600/oz., which allows the company to skew its stated production cost profile. If we don't count the company's New Afton project the company is breaking even on an operating basis at $1,200/oz. gold, and if we factor in costs that aren't included in AISC figures such as interest payments the company barely turned a profit in Q3 when gold was around $1,250/oz -- a low-cost miner would be turning a sizable profit at that price.
The Growth Myth
New Gold has some very large undeveloped deposits such as Blackwater, Rainy River, and its 30% stake in El Morro (with Goldcorp (NYSE:GG)). Investors and management like to point to these and say that New Gold has growth. Well we learned earlier this year that El Morro isn't moving forward any time soon due to environmental issues. Rainy River is moving forward but I have no idea how the company is going to get the $700+ million in order to develop the project given its $850 million debt position. What's more, I calculated that the project needs to have something like $1,400/oz. gold in order to have a positive NPV at 8% and the gold price has to go back to its all time highs for it to have a compelling IRR. Finally, Blackwater is a behemoth that is simply not going to be built at $1,200/oz. gold given its $1.8 billion price tag. Furthermore, it is going to take three years to build once the gold price does rise.
So maybe we will see some growth in four to five years, assuming gold rises, but other than that I see none.
These myths have propelled New Gold shares to a whopping $2.2 billion valuation as a ~400,000 oz. producer. That's only 50% higher than Kinross (NYSE:KGC), which produces over 2.5 million ounces of gold. Even if the company generates $200/oz. in net profits per ounce and we slap a 20-multiple on this we get a valuation of $1.6 billion. And this doesn't include the risks the company incurs in having $850 million in outstanding debt.
The Bottom Line
New Gold has garnered unwarranted attention and praise over the past few years. Despite its downfall from $15/share to $4/share, I suspect we will see more downside unless the gold price rises meaningfully -- in which case, why not just buy gold?
Goldcorp is another company that gold mining investors like to point to as a low-cost producer with growth, and again this is simply not the case.
The Low-Cost Myth
Goldcorp was barely profitable in the third quarter while at the same time the company was one of the better gold traders relative to its peers--it realized ~$1,280/oz. vs. New Gold, which got just over $1,230/oz. It reported AISC of $1,066 but its profits reveal costs that were about $100/oz. higher than this. This is higher than what we've been seeing. Now granted the company has just brought two mines online and shut down a third and so this figure may be temporarily high. However even if costs should have been $1,100/oz. that's still high, and the company is barely turning a profit.
The Growth Myth
This actually has been a growth company, with an emphasis on the past tense. While we will see the company grow its production at two mines next year -- Eleonore and Cerro Negro -- the company has no substantial growth prospects beyond this. Like New Gold, it has a stake in the back-burnered El Morro Project that is going nowhere for the time being. The company also has the Camino Rojo Project, which is a ~10 million oz. deposit in Mexico. While sizable, it is unlikely to be in production in the near future.
But even if the company does have a couple of growth prospects it has numerous projects that have limited lives and declining production. The company just closed one of its mines -- El Sauzal -- earlier this year. Its Red Lake Project, which was at one point its largest producer, is showing declining production figures every year. Most of the company's other projects are showing relatively flat production and dwindling reserves.
If the company makes an appropriate acquisition to combat this I will gladly change my tune on Goldcorp's growth, but so far we haven't seen anything.
The company made just $70 million in the third quarter at a gold price that was $85/oz. higher than today's. At that rate the company's $15 billion valuation is ~54 times higher than its annualized earnings at the higher gold price. Clearly it gets worse at $1,200/oz. gold. Now I don't mind paying lofty multiples for stocks that have the sustainable growth to support them, but we've seen that Goldcorp is struggling on this front.
In short, I think Goldcorp should be trading much lower unless the gold price really spikes, and in that case (again) why not just buy some gold in lieu of Goldcorp?
3. Tanzanian Royalty Exploration (NYSEMKT:TRX)
Tanzanian Royalty Exploration is down ~85% from when I said "sell" last September, but I see no reason to get involved at this point.
This one -- unlike Goldcorp and New Gold -- isn't a sell based on cash flow, growth and production costs. This is a company that has been saying that it is going to get its Kigosi and Buckreef Projects into production for quite some time and yet we've seen nothing to this effect as management drains cash. Management even put out a five-year production plan that outlines how this is going to grow into a leading African gold miner. Nothing has come of this.
The company fails to maintain the industry standard in investor relations. It has no investor presentation. CEO Jim Sinclair's blog hasn't been updated in 19 months, and finding out information about the company is generally difficult.
Furthermore, the company has recently been fighting a PR war as fellow Seeking Alpha author James Emerson recently wrote a negative piece about the company that calls its finances and general credibility into question. I received an email from Sinclair badmouthing the author. He even provided investors with his personal cell phone number so that they can bring their concerns directly to him. Even if Emerson is wrong -- and I don't think he is -- I don't like the fact that the company is wasting time on this PR war when it could be finding and mining gold.
A couple of final points. Jim Sinclair has no formal training to my knowledge in the mining space and one has to wonder what he is dong as the company's CEO. Even if the company's assets are fantastic they are in Tanzania, which is politically unstable. Finally, the company appears to be running out of cash. The bottom line is that this company is clouded with uncertainty and risks, and management fails to adequately address these concerns. With that being said I continue to believe this is a name worth avoiding in spite of its sizable downfall since I first went negative.
4. Primero Mining (NYSE:PPP)
Primero Mining used to be one of my favorites until it went out and bought Brigus. There were several problems with this transaction.
- Brigus' Black Fox Mine has relatively high costs and Primero was a legitimate low cost producer.
- Sandstorm Gold (NYSEMKT:SAND) owns a large stream on the Black Fox Project that decreases its effective realized gold price.
- When Primero bought Brigus it took on Brigus' debt, and this compromised Primero's excellent balance sheet.
- Management highlighted the production growth after the acquisition but it failed to mention that production growth on a per-share basis was nonexistent and that Cerro del Gallo would add fewer ounces on a per-share basis.
It got worse, however, after the acquisition. Black Fox had operational issues and costs have been way up while production has been way down. Furthermore, the company's compromised balance sheet forced it to back-burner Cerro del Gallo, meaning that now the company has no growth going forward.
Investors ignored this for much of the year until the stock started crashing in July. Now the valuation looks better but the company isn't making money at $1,200/oz. gold, which is too bad because its primary asset -- San Dimas -- is making money and Cerro del Gallo would have been making money as well.
So the acquisition was a costly mistake, and while valuation is starting to look a bit better Primero is at a point where it needs to prove itself once again. Right now -- despite its past -- Primero is a relatively high cost producer with no growth going forward, and this makes it a relatively unattractive name in the sector.
The Bottom Line
Going forward, I am extremely constructive on the gold market. While we could easily see another downward capitulation gold offers compelling value in a market that demonstrates a lack of understanding of its economic function. So I think investors should own gold. But there are innumerable ways to do this, and investors think that by owning miners they can get easy leverage, cash flow, and growth that make these stocks the obvious winners. But in several names investors are clinging to past successes that don't reflect current realities. Many one-time low cost gold miners are no longer low-cost producers (e.g., Primero, Goldcorp), and just because a company has grown in the past doesn't mean it is going to in the future (e.g., New Gold, Primero, Goldcorp). Finally, just because a gold miner has a gold celebrity as its CEO doesn't make it a quality investment (e.g., Tanzanian Royalty Exploration).
There are plenty of excellent gold miners out there and the recent downdraft in prices has left investors with several opportunities. Investors need to make sure that expectations are realistic and not based solely on anything in the past.
With this in mind, I warn investors against buying the aforementioned four names -- all of which have/had stellar reputations that are unwarranted in today's market. The next up-leg in gold is going to come with its own set of winners regardless of which companies were successful in the past. If you take this attitude and are able to single out the companies that have a realistic chance of growing their low-cost production bases, you could make an incredible amount of money.
Disclosure: The author is long KGC.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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