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Junior Gold Miners Versus The Big Producers

Articles & Blogs - Gold Commentary

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As we see the in-flux of “born again” gold-bugs among mainstream market commentators, there has also been a commensurate increase in articles about the gold miners. Many “experts” who only a couple of years ago were shunning gold as a “barbarous relic” now feel qualified to “recommend” individual gold miners to their readers.

To the credit of a few of these individuals, they have done their “homework”, and offer credible analysis and insight on the companies they cover. However, the majority of such pundits haven't learned the various quirks of this sector which make it different from all other commodity-producers. They engage in simplistic balance-sheet analysis which leaves investors dangerously uninformed about factors which have tremendous significance in the current and future performance of these companies.

In particular, we have numerous analysts touting the large gold-producers to their readers and clients, despite the consistent failure by most of these companies to deliver good “returns” to shareholders. Meanwhile, the smaller producers – the “junior miners” - have provided investors with many spectacular success-stories, with the best clearly still to come.

The leading “voice” when it comes to warning investors of the potential pit-falls of the larger mining companies is Jim Sinclair. He has told investors on countless occasions that many of these companies were carrying dangerous/destructive “gold derivatives” on their balance sheets – courtesy of the big-banks.

These derivatives were either incorporated into their operations as merely “hedges” against the gold-price or were a necessary condition in order to obtain financing for large, capital projects – such as the construction of a new mine. We’ve seen the results of these “deals with the devil” show up on the bottom-line of these mining giants: the complete inability to “leverage” the price of gold – either in terms of their own profitably or in returns to shareholders.

 

Company

closing price

3 years ago

% change

52-week high

52-week low

 

( in USD’s)

 

 

 

 

Goldcorp Inc

$40.16

$27.19

48%

$47.41

$32.84

Barrick Gold Corp

$41.73

$33.51

28%

$48.02

$32.17

Newmont Mining Corp

$58.17

$41.88

39%

$63.38

$38.53

Agnico Eagle Mines Ltd

$56.21

$44.01

28%

$74.00

$49.64

Yamana Gold Inc

$9.36

$12.38

-24%*

$14.37

$8.42

 

The table above shows five of the “brand names” among the small group of “senior” gold producers. Their stock performance over the past three years has been nothing short of dismal. While the price of gold has increased from $700/oz to $1200/oz over that period of time (roughly a 70% increase), these chronic under-achievers have (on average) only produced half that rate of return for shareholders – rather than “leveraging” the gold price, as all commodity-producers (should) do naturally.

Critics will argue that it’s misleading (and unfair) to include Yamana Gold in this three-year comparison, as they had completed a major take-over in 2007 – which led to a massive dilution of the share structure. Certainly, I could have come up with a better-performing choice than Yamana Gold. However, I wanted to include it in this analysis, as it illustrates two of the major problems facing the large gold-producers: the difficulty in trying to generate production growth and the need for these “gold miners” to add more and more base metals mining to their operations.

 

Because it’s nearly impossible for these “seniors” to generate “organic” production growth on their own, they are forced to regularly make large acquisitions – in order to add enough new mineral resources to their “pipeline”. As we can see with Yamana, trying to integrate these acquisitions into their operations is anything-but a “sure thing”. The second factor to drag on Yamana’s stock performance is that the company now produces a lot of copper with its gold.

“Pure” gold (and silver) miners trade at a premium compared to base metal miners. Unfortunately for the large producers, with large, straight gold-deposits becoming increasingly rare in the world, for these companies to find properties with a large enough gold-resource to make a significant contribution to their overall gold-production these miners are having to build polymetallic mines – where often the gold component in mine production (by cash value) is similar to (or even less) than its base metals production. In the case of Yamana, we see a glaring illustration of the (negative) repercussions for shareholders, due to these trends.

Then there are the “juniors”. To be sure, these companies present definite “risks” to investors, and exhibit dramatic volatility. This is why analysts who recommend these companies inevitably advise investors to acquire a “basket” of these miners. In addition, miner-ETF’s are coming out – where fund-managers choose their own “baskets”, for investors who can’t/won’t spend the time to select their own quota of companies. The rewards for favoring these companies over their larger-cap peers is obvious.

 

Company

closing price

1 year ago

% change

52-week high

52-week low

 

(in CAD’s)

 

 

 

 

San Gold Corp

$3.83

$2.45

56%

$5.00

$2.27

New Gold Inc

$5.13

$3.15

63%

$6.97

$2.93

Claude Resources

$1.07

$0.78

37%

$1.46

$0.61

Semafo Inc

$7.02

$2.25

212%

$9.13

$2.03

Golden Star Resources

$4.24

$2.48

71%

$5.02

$2.28

Red Back Mining Inc*

$25.52

$10.10

152

$28.94

$9.17

Colossus Minerals Inc

$6.62

$2.80

137%

$8.68

$2.47

Detour Gold Corp

$24.00

$9.80

145%

$24.94

$8.81

Timmins Gold Corp

$1.40

$0.59

137%

$1.56

$0.59

Premier Gold Mines

$4.74

$2.80

69%

$5.42

$2.47

Rubicon Minerals Corp

$3.50

$3.28

7%

$5.41

$2.67

 

Let me make it clear that I am not choosing a shorter period for comparison to artificially make these companies look better in comparison. One year ago, these companies had just finished massive run-ups in their share prices, as part of the global rally in equity markets, meaning that (if anything) this one-year period is unfair to the juniors. However, some of these companies simply didn’t exist in their present form three years ago. So illustrating how these companies have out-performed the three-year performance of their larger brethren in one year is something done out of necessity – not “convenience”.

I should also point out that while I wanted to (generally) choose companies that were among the better performers that I made no effort to locate and identify the “best performers” among the junior miners. The vast majority of these companies were selected from our database of miners (compiled by our own Brian Boutilier), with a few names added from the holdings of the Van Eck junior miner-ETF (GDXJ).

There are also several points to mention about these companies, individually. To begin with, one of the companies listed is obviously not a “junior” at all. Red Back Mining Inc is a very well-run “intermediate producer” – who will quickly achieve the status of a “senior” if it can maintain its recent stellar record of growth. However, the company has recently announced a “hiccup” in the development of one of its mines, and has been forced to make a minor, downward revision in its production forecast for this year.

While a “bad year” for this company will likely be as good as a “good year” for most of the seniors, there are no guarantees here. Though the mid-cap miners offer better growth prospects than the seniors, they also share many of the same problems. As a result, the performance of mid-tier gold producers is (literally) “all over the map” – and thus picking a “winner” among these companies is arguably just as difficult as doing so among the juniors, where generating strong year-over-year growth is easier in many respects.

Readers will note that the bottom-half of companies in the table are, in fact, not “producers” at all. Instead, they are officially “exploration” companies. Some of them are very close to becoming producers, while others are still at an earlier stage of development. While it is true that there is even more “risk” with these companies than with producers, it is very important for investors to understand the nature (and level) of such risk.

Two of these companies are personal holdings: Detour Gold and Colossus Minerals, and so I am very familiar with their respective projects. Detour Gold is moving toward production on a 15-million ounce gold deposit, favorably situated in the province of Ontario. It just raised nearly $300 million, in an offering which was over-subscribed.

What is the “risk” with this company? Well, a huge earthquake could swallow-up the mine…? Seriously though, the risk which investors face with a company like this is very similar to that with junior producers. Unless you have a bearish opinion on the future price of bullion, then the “risk” is not that investors will lose money, but simply that they will have to wait to enjoy the sort of success which these companies can provide when development proceeds on schedule.

With Colossus Minerals, its Serra Pelada property in Brazil was initially the site of the greatest “gold rush” in Brazilian history. To say that prospectors were finding “bonanza grades” is a gross understatement. Current (and “historical”) drilling “intercepts” are simply hitting the richest ore I have ever encountered in my own history as an investor. With exploration still at a relatively early stage, the obvious risk with this company is that it’s simply not able to find a large enough tonnage of this fabulous ore in order to make a mine commercially viable. Given the location of the deposit (the Amazon jungle), the other obvious "risk factor" is whether the company will be able to obtain the necessary environmental permitting for commercial mining.

For investors who hold a basket of these companies, it becomes quite easy to be patient with some of these holdings, as long as you are able to find some who do live-up to their potential in the near-term. Given that there are more than a hundred of these companies to choose from (just among companies with North American listings), it does take time to separate the “contenders” from the “pretenders” – however the reward for doing so successfully certainly would justify that effort in the minds of most investors.

At the same time, investors must also be aware of the volatility of these companies, even relative to each other. The last two names on my list of juniors are two of the premier “pure exploration” companies in the entire junior sector: Premier Gold and Rubicon Minerals. Both companies were at a very similar price one year ago, both have had almost identical 52-week highs. However, today the share price of Premier Gold sits more than 30% higher than Rubicon Minerals.

Does this mean that investors should be dumping their Rubicon in order to buy shares of Premier? Hardly. “Buying high” and “selling low” has never been a successful investment strategy. Instead, what it illustrates is that shareholders must resist the urge to dump these companies simply due to a lack of patience. As companies of similar quality, it would be no great surprise if Rubicon was able to close the gap with Premier – and even pass it. It also illustrates that the market does not value these companies consistently, meaning that value-investors will regularly be able to uncover companies at very attractive prices.

Defenders of the large-caps will point to the large spreads between 52-week highs and lows, and argue that there is plenty of “profit potential” among the “brand names” in the gold sector. In fact, most of those investors who deliberately opt for the (supposed) “security” of large-cap companies do so in order that they don’t have to be constantly “flipping” these companies to manage a decent return on their holdings.

If an investor is going to engage in the extra trouble (and risk) associated with moving in and out of positions, then they might as well forget about the seniors – and focus strictly on the juniors (and the odd mid-cap miner). Not only are the juniors better performers as “buy-and-hold” investments, but for those who relish the opportunity to trade them, (as we can see) the spreads between the 52-week highs and lows for the juniors are enough to make even experienced traders salivate.

For the large portion of Bullion Bulls Canada readers who are ardent “silver bulls”, I don’t want you to think that I’ve “snubbed you” by not mentioning the outstanding investment opportunities among dozens of “junior” silver miners. Instead, much as the fundamentals for silver are much different than those for gold, the fundamentals for silver miners are equally unique.

To satisfy the “other half” of our audience, I’ll devote an entire commentary to explaining those fundamentals – and the interesting choice which it implies between the gold and silver miners.

 

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Comments (5)Add Comment
Jeff Nielson
...
written by Jeff Nielson, July 25, 2010
Yes, Claude, I really haven't talked much about OTHER commodities for quite a while, but for those wanting to "diversify" in order to not be too "heavily weighted" with precious metals, other commodity sectors represent great "hard assets" to add to portfolios.

Like you, I'm leaning toward "fertilizer stocks" (as a play on "soft commodities") and hopefully one of these days I'll start making some money on those stocks (lol). Seriously though, from my vantage point, fertilizer stocks look like excellent values.
sailortony
...
written by sailortony, July 25, 2010
Hi Jeff, thanks for your comments on BMO . I will top up with this ETF as well as XMA for the Gold & fertilizers majors before the end of the summer.

No gremlins problem from my end!
Jeff Nielson
...
written by Jeff Nielson, July 25, 2010
Editor's note: We have had some "gremlins" in our software lately - which seems to be affecting the registering of comments, and sending messages. If you have had any recent problems with either of these issues (or any other "weird" occurrences) please let us know about them - or at least TRY to (lol).
Jeff Nielson
...
written by Jeff Nielson, July 25, 2010
Hi Claude. It looks like a nice mix of companies. It's not quite as "spread out" as GDXJ, so if BMO did a good job of making their picks, it should outperform that fund.
sailortony
...
written by sailortony, July 25, 2010
What do you think of the BMO ETF as a way to play the Juniors?
http://www.etfs.bmo.com/bmo-etfs/glance?fundId=75750

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