Gold and the Dollar

Junior Gold Stock Comparison

In the 25th June Interim Update we included a valuation comparison of 15 junior gold stocks. Below are updated versions of the comparison tables covering the original 15 stocks plus 6 new additions. 

In the below tables EV stands for "enterprise value" and TEV stands for "theoretical enterprise value". The enterprise value (EV) for each gold producer is calculated by adding the company's net debt to its stock market capitalisation, where net debt is total debt minus cash. In the case of companies that are not yet in production (about half the companies in the list) the calculation of the current EV also includes an estimate of future mine development cost (by doing this we hopefully create more of a level playing field). In other words, EV represents the current total market value of each company. TEV, on the other hand, is what each company's gold reserves are theoretically worth at a particular gold price. It is calculated by multiplying a company's net profit margin per ounce of gold (the assumed gold price minus the total cost (expected future cost in the case of non-producers) to produce an ounce of gold) by that company's total gold reserves. In the tables we've noted each company's TEV at $350, $425 and $500, and also the percentage change that would be needed to bring the current market price into line with the calculated TEV. In other words, the percentages shown in the final three columns reflect the gain that the market would bestow on each stock at various gold prices if the valuation criteria we have used in compiling this table were the market's only consideration.

In the first of the following tables the companies are shown in order of value, from best value at the top to worst value at the bottom, assuming a gold price of $350. In the second table the companies are once again shown in order of value, but this time assuming a gold price of $500. Note that "Adj. Resv." in the tables stands for "adjusted reserves" and is calculated, for each company, by adding 50% of the company's "measured and indicated resource" to its "proven and probable reserve".
 

Company Name	Symbol	Recent Price (US$)	Ent. Value (US$M)	Total Cost per ounce	Adj. Resv. (Moz)	EV $ per oz Res.	TEV at $350	TEV at $425	TEV at $500	Gain at $350	Gain at $425	Gain at $500
Bendigo Gold	BDG	0.15	285	200	6.0	47	900	1350	1800	216%	374%	532%
Gallery Gold	GGN	0.11	74	240	1.8	42	193	324	455	160%	336%	513%
Desert Sun Mining	DSM	0.93	53	240	1.2	46	128	215	302	139%	301%	464%
Afrikander Lease	AFKDY	0.67	147	247	3.1	47	319	552	784	117%	275%	433%
Redback Mining	RBK	0.27	82	240	1.6	52	172	289	406	110%	253%	396%
Metallica Resources	MR	1.15	89	300	2.8	32	140	350	560	57%	291%	526%
American Bonanza	BZA	0.22	58	210	0.6	97	84	129	174	44%	121%	198%
Western Silver	WTZ	3.03	169	260	2.7	63	243	446	648	44%	163%	283%
Metallic Ventures	MVG	2.76	113	260	1.6	70	144	264	384	28%	134%	241%
Cumberland Resources	CBD	2.56	193	228	2.0	96	244	394	544	27%	105%	183%
McWatters Mining	MWA	0.10	54	321	2.3	24	66	238	411	21%	339%	656%
Golden Phoenix	GPXM	0.35	54	300	1.3	43	64	160	256	18%	194%	370%
Emporer Mines	EMP	0.36	36	333	2.3	16	38	211	383	6%	480%	955%
Eldorado Gold	EGO	2.16	494	276	7.1	70	520	1049	1578	5%	112%	219%
Apollo Gold	APG	2.07	131	300	2.6	51	129	322	515	-2%	145%	293%
Aquiline Resources	AQI	0.51	29	240	0.3	115	28	46	65	-4%	61%	127%
Novagold	NRI	3.60	269	250	2.5	108	250	438	625	-7%	63%	132%
Golden Star Resources	GSS	3.55	333	243	2.7	126	284	483	681	-15%	45%	104%
Orvana Minerals	ORV	1.02	133	160	0.6	238	106	148	190	-20%	11%	43%
Richmont Mines	RIC	3.65	30	335	0.5	57	8	48	88	-74%	59%	191%
Bema Gold	BGO	1.98	663	333	9.6	69	168	888	1608	-75%	34%	143%

Company Name	Symbol	Recent Price (US$)	Ent. Value (US$M)	Total Cost per ounce	Adj. Resv. (Moz)	EV $ per oz Res.	TEV at $350	TEV at $425	TEV at $500	Gain at $350	Gain at $425	Gain at $500
Emporer Mines	EMP	0.36	36	333	2.3	16	38	211	383	6%	480%	955%
McWatters Mining	MWA	0.10	54	321	2.3	24	66	238	411	21%	339%	656%
Bendigo Gold	BDG	0.15	285	200	6.0	47	900	1350	1800	216%	374%	532%
Metallica Resources	MR	1.15	89	300	2.8	32	140	350	560	57%	291%	526%
Gallery Gold	GGN	0.11	74	240	1.8	42	193	324	455	160%	336%	513%
Desert Sun Mining	DSM	0.93	53	240	1.2	46	128	215	302	139%	301%	464%
Afrikander Lease	AFKDY	0.67	147	247	3.1	47	319	552	784	117%	275%	433%
Redback Mining	RBK	0.27	82	240	1.6	52	172	289	406	110%	253%	396%
Golden Phoenix	GPXM	0.35	54	300	1.3	43	64	160	256	18%	194%	370%
Apollo Gold	APG	2.07	131	300	2.6	51	129	322	515	-2%	145%	293%
Western Silver	WTZ	3.03	169	260	2.7	63	243	446	648	44%	163%	283%
Metallic Ventures	MVG	2.76	113	260	1.6	70	144	264	384	28%	134%	241%
Eldorado Gold	EGO	2.16	494	276	7.1	70	520	1049	1578	5%	112%	219%
American Bonanza	BZA	0.22	58	210	0.6	97	84	129	174	44%	121%	198%
Richmont Mines	RIC	3.65	30	335	0.5	57	8	48	88	-74%	59%	191%
Cumberland Resources	CBD	2.56	193	228	2.0	96	244	394	544	27%	105%	183%
Bema Gold	BGO	1.98	663	333	9.6	69	168	888	1608	-75%	34%	143%
Novagold	NRI	3.60	269	250	2.5	108	250	438	625	-7%	63%	132%
Aquiline Resources	AQI	0.51	29	240	0.3	115	28	46	65	-4%	61%	127%
Golden Star Resources	GSS	3.55	333	243	2.7	126	284	483	681	-15%	45%	104%
Orvana Minerals	ORV	1.02	133	160	0.6	238	106	148	190	-20%	11%	43%

Notes and conclusions:

1. Please read the analysis that accompanied the comparison tables in the 25th June Interim Update because the comments made about specific stocks at that time still apply. Most of the below comments deal with the new additions to the tables.

2. We haven't taken hedging into account in our valuation comparison. Of the companies included in the above tables only Emporer Mines (ASX: EMP), which operates a mine in Fiji, and McWatters (TSX: MWA) have done significant hedging of their future gold production. Had we considered the effects of these hedge books when estimating the values of these companies at a $500 gold price the change in our valuation of MWA would not have been material but the valuation of EMP would probably have fallen by 20%-30%. However, EMP is presently so under-valued that even if we lopped 30% off its theoretical value at a $500 gold price in order to account for the opportunity cost of the hedge book the stock would still be at the top of the second table.

Durban Deep (DRD) owns 20% of EMP and DRD's CEO (Mark Wellesley-Wood) sits on EMP's board. Furthermore, Wellesley-Wood recently said that DRD was looking to expand its Australasian business by acquiring a company or companies that are already in production (as opposed to acquiring exploration-stage companies). Given DRD's current involvement and EMP's extreme relative under-valuation it is not much of a stretch to conclude that DRD will eventually make an offer for EMP. Hopefully, the offer will come after the stock has already moved well above its current level.

3. When a company appears to be extremely under-valued relative to its peers there is usually a good reason. In EMP's case there is a significant hedge book, political risk because the company operates in Fiji, and poor recent production results due to lower grades. In MWA's case the stock is very cheap because the company has issued a massive number of new shares over the past several months in order to raise money and because there have been some operational problems. An investor therefore needs to ask himself/herself the following question: Is the apparent discount in the price sufficient to make the stock a buy in spite of the obvious problems? In the case of both EMP and MWA we think the answer to the question is yes and that both stocks have attractive risk/reward ratios at their current prices.

4. Metallica Resources (OTCBB: METLF) scored well in terms of its leverage to the gold price. Actually, half of this company's in-ground resource is silver so the stock is as much a silver play as it is a gold play. The company is probably going to issue a large amount of new equity at some point over the next 6 months. When the stock was added to the TSI Stocks List we therefore suggested that investors take an initial position immediately and then add to the position into significant weakness following an equity raising.

5. Afrikander Lease (JSE: AFL, OTC: AFKDY) is a junior South African gold producer that is expected to grow very quickly over the next few years (from 70,000 ounces of production this year to annual production of 300,000 ounces in 2006). Like all South African mining companies AFL is going to struggle if the Rand continues to strengthen, but if the Rand started to weaken (see the Rand chart included later in today's commentary) then AFL would be a reasonable stock to own due to its strong growth profile.

6. Gallery Gold (ASX: GGN) is about to commence construction of a 100K oz/year mine at its Mupane project in Botswana and also has substantial gold resources in Tanzania. The stock represents very good value at its current price. As is the case with a number of the other small gold mining companies we follow, at some point over the next few months GGN will need to raise a substantial sum of money in order to finance mine construction. This, when it occurs, will probably put some pressure on the stock price.

7. Both NovaGold (TSX: NRI) and Aquiline (TSXV: AQI) fared quite poorly in terms of their relative valuations at a gold price of $500, but this is because only current reserves and measured/indicated resources are considered in the above tables. In NRI's case there is a massive inferred resource at Donlin Creek that will almost certainly be brought into the measured and indicated category over the next year or two. In AQI's case the drill results released over the past month strongly suggest that its eventual resource will be much greater than the 500K ounce figure used in our calculations. 

Gold Forecast

In the 23rd July Interim Update we included a chart illustrating what we considered to be the two most likely outcomes for the gold price over the remainder of the year. Both outcomes were bullish, with one being that a major advance was already in progress and the other being that the consolidation process would continue for a couple more months before a major advance got underway. Below is an updated version of this chart. As was the case in the previous commentary, we've included a chart of the euro below the chart of the gold price since any gold price forecast must be consistent with a currency market forecast (and vice versa).

In order to arrive at a reasonable upside target for the gold price over the next several months we've used a chart of the gold price in euros. We've done this because the major channel top for the euro gold price is well defined. Previous rallies in the gold price over the past few years have ended at the top of the channel shown on the below chart and if the current rally does the same then a logical upside target for gold is 370 euros. Assuming a euro-US$ exchange rate of 1.25 gives us a medium-term upside target for the US$ gold price of around $460.

Currency Market Update

Below is a chart showing the Australian Dollar in terms of the euro (the line on the chart rises when the A$ is out-performing the euro). Over the past few years the A$ has done well relative to the euro during those periods when the US stock market has been strong and has fared poorly during the stock market declines (the boxes on the chart identify the periods when the stock market was strong or stable). The AUD-EUR rate reversed lower at around the time the stock market was peaking in June-July. If the stock market behaves roughly in line with our current expectations then the A$ will probably be very weak, relative to the euro, during the first half of next year.

After being one of the weakest currencies in the world for many years the South African Rand has been the strongest currency in the world since late-2001. However, the below chart shows that it wouldn't take much of a fall in the Rand to break the trend-line that began almost 2 years ago (note that a falling line on the chart indicates a strengthening Rand). It is quite possible that the US$-Rand exchange rate bottomed in April and that the recent weakness (strength in the Rand relative to the US$) is a test of that bottom. A decisive move above the trend-line drawn on this chart would suggest that this was, in fact, the case, and that a substantial counter-trend rally was underway. Such a rally in the US$ relative to the Rand would, of course, benefit the SA-based miners.

Earlier this year the Dollar Index bounced off support defined by its 1998 low, but we don't have any technical or fundamental evidence that a major low is in place for the US$. However, we do expect the dollar to receive substantial buying support once it drops to the vicinity of its 1995 low. We expect that the 1995 low will be reached by mid 2004.

Current Market Situation

Below is a daily chart of December gold futures. After having bounced off its 200-day moving average during the week before last gold had managed to move above both its 18-day and 50-day moving averages by the end of last week. Provided gold doesn't close down by more than $2 on Monday we will therefore have confirmation that a pullback low was put in place on 1st August.

We are skeptical of gold's ability to hold above the 200-day moving average during its recent pullbacks because this widely-watched level often has to be broken before a sustainable bottom occurs (as was the case earlier this year). However, the behaviour of the gold shares suggests that the gold price is about to move sharply higher. Anyway, regardless of whether or not we get a drop below the 200-day moving average over the next few weeks we will be very surprised if gold does not trade well above $400 before the end of this year.

Below is a chart of the HUI/gold ratio. The rise in the ratio to near its mid-1996 level suggests that there is little additional upside potential in the senior gold stocks relative to the gold price. In other words, any further gains in the senior gold stocks will probably need to be accompanied by equivalent percentage gains in the gold price. If we owned any large-cap gold stocks (we don't) we'd be starting to scale-out now and would probably be shifting our investment funds from the stocks to the bullion. As confirmed by the valuation comparison included earlier in today's commentary there is, however, a lot of potential upside in the junior gold stocks and we are not inclined to take any profits on our junior gold stocks at this time. However, we will probably exit some of the juniors if the gold price accelerates higher over the next few weeks. When the appropriate time to do some selling does arrive, the decision as to which stocks to exit will be made by taking into account both valuation and price action.

By the way, as we've discussed in the past it makes little sense to forecast the gold price based on the dollar's current price action and to forecast gold stocks based on gold's current price action. It does, however, make sense to forecast gold based on what is happening to gold stocks and to forecast the dollar based on what is happening to gold. In the current situation, with gold stocks leading to the upside, it is likely that gold stocks will peak before gold peaks and that gold will peak before (perhaps well before) the dollar bottoms. For example, we wouldn't be surprised if the final $50 up-move in the gold price occurs AFTER the major gold stock indices have peaked and if the final plunge in the US$ occurs AFTER the gold price has peaked.

Below is a weekly chart of the silver price. Silver did what it was supposed to do over the past week and pulled back to the former resistance area (now support). We continue to expect that silver will make its way up to at least $5.80 over the next few months. 

Update on Stock Selections

In the 30th July Interim Update we briefly discussed the way junior mining companies use private placements of new shares to raise money and said that the best the management of these companies can generally do is to time the placements to coincide with stock price strength. Wheaton River (TSX: WRM, AMEX: WHT) is definitely not in the junior category anymore, but its recent announcement of a large equity placement is a good example of how such deals ideally should be timed.

Below is a chart of WRM. On the day prior to the announcement of the new issue WRM had hit resistance defined by the all-time high reached in May of 2002, so a pullback in the short-term was likely with or without the new issue (especially given the large advance in the shares over the preceding 2 months). As such, the new equity issue simply assisted in prompting a pullback that would have happened anyway. Also, the new issue was priced at a slight premium to the market price at the time and the warrants issued as part of the deal were well out of the money. This means that the financing will not dilute the value of existing shares. 

Given the large size of the financing (C$100M) it is probable that WRM's management has another acquisition in mind.

The feasibility study on Desert Sun Mining's (TSX: DSM) Jacobina gold project in Brazil is due to be complete later this month. A positive feasibility study (we see no reason why it won't be positive) will confirm that DSM is worth more than C$2/share assuming no increase in the gold price.

In the 2nd July Interim Update we explained why NovaGold (TSX: NRI) was probably worth around C$6.60/share assuming no increase in the gold price. NRI has since moved up from $3.25 to $5.00 and is still reasonable value, although the stock is obviously not as attractive now as it was 6 weeks ago. We don't think it makes sense to purchase NRI now given the recent surge in its price, but buying following a pullback to near the top of its former channel (see chart below) might make sense for those looking for relatively low-risk exposure to some gold juniors. 

Although we think the odds favour new recovery highs in both the S&P500 and the Dow over the next few months, the risk/reward ratio for the US stock market is terrible. If new highs are achieved they will most likely only be a few percent above the June-July peaks, but we estimate that the market has downside risk of 30%-50%. As such, longer-term investors should remain out of the US market except for a few special situations such as gold stocks and, to a much lesser extent, commodity-cyclical stocks.

Due to the market's poor risk/reward we are going to add another QQQ put option position to the Stocks List at this time. We'll add a second position in the QQQ December-2003 $25 put options (QAVXY) using Friday's closing price of US$0.60 for record purposes. If the market falls sharply over the next few weeks we will probably take the opportunity to exit all December-2003 put options with the aim of entering longer-dated QQQ put options (options that expire during the second half of 2004) later this year. 

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Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://bigcharts.marketwatch.com/
http://www.futuresource.com/