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Buy Rangold Resources While There Is Still Blood In The Streets

|Includes: GLD, Randgold Resources Limited (GOLD)

Randgold resources (GOLD US) had dropped 26% from its peak only 1 month ago, even though the price of gold, its main product, has fallen only 5.8% in the same time. The main catalyst for this fall was a coup de tat on March 22, but the beauty of owning a mining operation is that the underlying value of the company is indestructible. Not even natural disasters can really have much effect, let alone a little man-made skirmish.

Rangold has always traded at a very consistent multiple to the value of these researves, less cash costs of extraction, of about 1.2 to 1. It now trades at a 50% discount. If one is worried about the price of gold, it is easy to hedge that with puts on the metal or on index funds that own gold, such as GLD.

Technically, the firm value is also determined by the cost and time it takes to extract these reserves, and a pro-longed war could easily disrupt the supply of equipment, but this is not what is happening. There has been no significant interruption of mining operations. The airport was briefly closed, but has re-opened. All borders are open, and the materials that need to be transported to and from the mines go through southern borders that are hundreds of miles from any sign of violence.

Since I originally wrote this piece, there have been threats by the international community to sanction the new regime in ways that would cut-off cross border trade. So far, the coup leaders have voiced their willingness to talk, and the threats have not been acted upon. If sanctions are enacted, they would result in delays in the realization of the value of the mines, not in destruction of the value.

As will become clear from arguments below, the sanctions are unlikely to last long enough to have an effect that is worth 26% of the value of the mine. No matter what happens, the time to buy this stock is now, when the level of fear is at its highest and most irrational. Once there are any talks or discussions aimed at removing the threat of sanctions and leading to restoration of democracy, the stock will be bid only. Before that happens, you want to be the one who can offer the stock, not the one trying to get some.

Some investors might have feared that the new government would nationalize the mines or otherwise tax or regulate the mining operations unfairly. but there is no reason to believe anything of the sort will happen here. Mali is an extremely poor country, with more than half the population living on income of less than US$1.25/day. Gold is the country's leading export and the only export that is not susceptible to drought or disease. No government can afford to treat the gold mining industry poorly and expect to survive. One of the first things the coup leaders did after securing their power was to meet with the gold minors to ensure that all of their needs were being met.

But this discussion is taking the margin of safety rule to a ridiculous extreme anyway. The coup leaders have no political agenda and no desire to involve themselves in the operation of government. They are disgruntled soldiers, eager to stop a war that that they have no interest in fighting. They are not interested in money, or economics, or taxes, or anything other than avoiding meaningless death, which is not exactly an ignoble cause. While they may need time to secure their own pardons, there is otherwise, no reason for them not to return power to elected politicians.

In the most recent quarter reported, Rangold's cash cost per ounce of gold was $753, while the average selling price was $1,666. Proven & probable reserves were 149mn ounces of gold, of which 11% is high-grade gold, leaving 16.4mn ounces. Multiplied by cash profts per ounce of $913, this gives an admittedly crude estimate of fair value of $164 per share. All things being equal, the shares would trade at a discount to this value because it takes time to extract the value, but Rangold has always traded at a premium to this value because investors have correctly credited the company with an ability to increase its reserves. A change in the company's ability to increase these reserves might easily explain why the company was no longer valued at a premium in 2011, but within a matter of weeks, or perhaps months, there will be no reason for the shares to be trading at a larger discount to the net value of reserves than they were a month ago.

Chart 1: Value of Reserves Less cash Costs Per share vs. Share Price

Source: Company reports

Disclosure: I am long GOLD.

Additional disclosure: I am long GOLD and Short GLD through options of various strikes and durations. I receive no compenstation to write aobut any specific stock, sector, or theme.