An Investment Idea to Consider
McEwen Mining, Inc (NYSE:MUX)
By: Sean Gurson, CFA Candidate
January 23, 2014
Disclosure: I am long MUX
Recommendation: Go long $MUX
McEwen Mining Inc. engages in the exploration for, development of, production, and sale of gold, silver, and copper. The company's principal assets consist of a 49% interest in the San José Mine in Santa Cruz, Argentina; the El Gallo complex in Sinaloa, Mexico; the Gold Bar Project in Nevada, United States; and the Los Azules Project in San Juan, Argentina, as well as a portfolio of exploration properties in Argentina, Nevada, and Mexico. As of December 31, 2012, it had an aggregate land position of approximately 4,988 square kilometers. The company was formerly known as US Gold Corporation and changed its name to McEwen Mining Inc. in January 2012. McEwen Mining Inc. was founded in 1979 and is headquartered in Toronto, Canada.
Qualitative Buy Factors
A bet on McEwen Mining is a bet on the man behind it: Rob McEwen. In the 1990's, Rob McEwen transformed Goldcorp from a $50 million dollar market cap company into a $10 billion dollar market cap company, despite several years of declining gold prices, making him a very rich man. And now, after giving away over $25 million to charity (which speaks to his character), he wants to do it all over again, except this time, he is really putting his money where his mouth is. He invested $125 million for 25% of MUX, valuing it at $500 million, and he is not even taking a salary. Practically the only way he makes money, is if the market cap of MUX ends up higher than $500 million. In fact, his goal is for MUX to qualify for inclusion in the S&P 500 (currently, the only other gold miner on the S&P 500 is Newmont Mining, NEM). At MUX's 52 week low in June, 2013, astute investors could have bought shares for less than McEwen himself paid, around $1.68 per share.
In 2011, Rob McEwen predicted gold would reach $5,000 per ounce by 2016, and stood by his prediction in an interview in November of 2013. (http://www.bnn.ca/News/2013/11/1/Why-Rob-McEwens-bullishness-on-gold-is-unshaken.aspx)
He seems to believe that rising interest rates, uncertainty in world markets, growing demand for gold from China and India, and the possibility of the Chinese yuan renminbi becoming the world's reserve currency will all factor into the investor psychology behind rising gold prices.
Quantitative Buy Factors
MUX has zero long term debt. This is a rare feature among companies in such a capital intensive industry as gold mining. In fact, of the 18 companies listed within the NYSE's gold mining subsector, only two others have zero long term debt: Alamos Gold (NYSE:AGI) and Seabridge Gold (NYSEMKT:SA).
Having zero long term debt is particularly advantageous to an investor because it greatly increases the certainty of their investment. Here's why: Only two things can happen after investing: either the price of gold goes up or the price of gold goes down. The good news is, MUX investors make money in either case.
Case 1: The price of gold goes up.
Gold is currently trading between $1,200 and $1,300 per troy ounce. According to MUX's most recent filings, its cost per gold equivalent ounce mined is between $700 and $800 and its all in sustaining costs are between $1,100-$1,200 per gold equivalent ounce. Last year MUX produced close to 140,000 gold equivalent ounces and it expects to produce 170,000 gold equivalent ounces in 2015 from its current mines. On January 21, it received a permit to construct another mine, El Gallo 2. If MUX proceeds with the construction of this mine (which is likely, because they wish to secure better financing at a rate that was not available before receiving their permit), El Gallo 2 is projected to produce 95,000 gold equivalent ounces at an all in cost of $800 per ounce. In other words, there is a good chance that by 2016, MUX will be producing over 235,000 gold equivalent ounces at an average all in cost per ounce of around $1,000.
In the best case scenario, If Rob McEwen's prediction of $5,000 gold comes true, MUX will be earning $4,000 per gold equivalent ounce of production, or 235,000 gold equivalent ounces x $4,000 per ounce = $940 million per year. At a 10x P/E multiple, MUX would be worth $9.4 billion within a few years. It is currently selling for $782 million (its market capitalization). Obviously, this is a very rosy scenario.
Case 2: The price of gold falls.
First, if the price of gold falls below MUX's all in sustaining costs of between $1,100-$1,200 per gold equivalent ounce, MUX will have several options. First, because MUX has zero long term debt, it will be able to borrow a significant amount of money to weather the storm, and since it is a low cost miner of gold, it will simply continue operating until unprofitable companies shut down and demand for gold once again surpasses supply. Borrowing money will also improve MUX's operating and other financial ratios, while bringing its balance sheet metrics into alignment with those of competitors which are already saddled with debt, thereby potentially making MUX's stock price relatively more attractive and offering long term investors downside protection via short term investor psychology supply and demand dynamics.
Second, and this is an option Rob McEwen has undertaken in the past, is to simply wait for the price of gold to rebound. While turning Goldcorp from a $50 million company into a $10 billion company in the 1990's, Rob McEwen initially faced several years of declining gold prices. What did he do? He simply stopped selling the gold that Goldcorp was producing, and waited for prices to rebound. He later sold the gold at much higher margins. He anticipated price increases and reduced supply to partly inflate prices.
Third, when we use history as a guide, certain macroeconomic and competitive forces seemed to overpower declining gold prices and drive the price of gold miners up. Consider the Dow/Gold chart below. We are currently on the very right end of the chart. What if the gold continues to outperform the Dow? We discussed this case above, and MUX will do great in that case.
But in the case that the Dow begins to outperform gold, the way it did during the 1980's, the growing economy will inflate price multiples and overall asset prices, high cost producers of gold will begin to fail, and industry consolidation will occur. We can rest assured that Rob McEwen is the right man to navigate such murky waters and that MUX's strong balance sheet will keep the ship afloat. Also, if the Dow begins to outperform gold going forward, consider what happened to two of the bigger producers of gold, Newmont Mining (NYSE:NEM) and Barrick Gold (NYSE:ABX) when exactly this situation occurred during the 1980's (please refer to the chart). After 1985, the price of Newmont's and Barricks's stock exploded over the following decade.
According to the second chart, gold prices have historically tended to remain low during high interest rate periods. Certainly, in a few years, we can expect higher interest rates, but as discussed above, this would likely entail the Fed trying to cool a heating market by raising rates, and likewise, the Dow would outperform gold.
The Economics of Gold and the Current Macroeconomic Picture
If the economy improves and gold prices remain steady, MUX's increased production will preserve and drive its stock price. If we continue to face turbulent and unstable markets, people will flock to gold and drive prices up. MUX seems to be a win-win.
I believe Ray Dalio, founder of the hedge fund Bridgewater, has a powerful framework for understanding the current macroeconomic picture. I agree with his assessment on where the U.S. economy stands today. According to him, the U.S. is in the middle of a post-recession short term debt cycle, where assets will return about 4% over the coming few years. (http://www.businessinsider.com/ray-dalio-davos-cnbc-2014-1 and http://www.economicprinciples.org/)
He goes on to say in his video, "How the Economic Machine Works", that the U.S. is coming out of a long term debt cycle (which typically last between 50-70 years), in what will hopefully be a "beautiful deleveraging".
The total debt to GDP ratio of each of the following countries is higher than that of the United States: Japan, the United Kingdom, Spain, France, Italy, and South Korea. (http://www.gfmag.com/tools/global-database/economic-data/11855-total-debt-to-gdp.html#axzz2rGQGr8Gm)
Investors will be facing very high uncertainty about these countries in the coming years as their debt levels grow.
Based on Dalio's assessments, (or the "Dalio Lama", as I like to call him) the European debt crisis, and the powerful long term charts below, it is difficult even to obtain a broad sense of where the price of gold is headed in the next few years. But one thing remains certain, the uncertainty of the world economy. And with a rise in uncertainty comes a rise in gold prices.
Disclosure: The author is long MUX.
Disclosure: I am/we are long MUX.