Treasure Chest | May 15 2012
This story features PERSEUS MINING LIMITED. For more info SHARE ANALYSIS: PRU
By Greg Peel
FNArena's earlier article Newcrest: The Great Frustrator highlighted the disappointment investors have felt from five years in underperformance from the country's, and one of the world's, largest gold mining companies. Yet while Newcrest ((NCM)) has its own specific problems, underperformance of gold miner shares has been an issue across the globe. Share price movements of the gold miners traditionally lag movements in the price of gold, but the US dollar price of gold has risen 30% in the past three years while the GDX index of large US gold stocks has fallen 20% in the same period.
There are many issues facing gold miners which suggest the value of a mining company will never closely reflect the price of gold. Production delays, low grades, machinery issues, the weather – you name it, gold miners suffer from them all – are all problems which undermine share prices, and that's not to mention the current pressing global issue of rapidly rising costs.
However there is another way to look at the value of gold miner shares, as suggested by Don Coxe of Coxe Advisors. Coxe's insight has proven sufficiently robust an argument to swing respected trader and long term gold fan Dennis Gartman back from eschewing the miners in favour of exchange-traded funds (ETF) as a gold investment vehicle, as Gartman explains in his recent newsletter.
Coxe's argument comes down to what is known in mining parlance as a “resource” and what is known as “2P”, or “proven and probable” reserves. One can also stretch this to “3P” to add “possible” reserves. Says Coxe:
“If you buy the ETF you get only the full move in gold, but no embedded optionality. If you, for example, buy a gold miner with 20 years of 2P reserves and 7 years of resource you have a call on gold price appreciation for free.”
A gold mining project will typically feature a resource of sufficient grade and accessibility to make mining a commercially viable proposition at today's gold price. Further reserves may be of lower grade or, say, further underground, meaning they are not worth extracting at today's prices and costs. But as the gold price rises, as it has done steadily since early last decade, reserves once considered possible then become upgraded to probable and perhaps eventually proven. Thus what Coxe is suggesting is that if you buy gold, you've only got gold. If you buy a gold miner, you have the potential to see value increasing above and beyond a move up in the price of gold as a resource increases.
Coxe's gold analyst recently crunched some numbers on this assertion, assuming a US$1000 “gold” investment. If you buy ETF units then US$1000 will get you 0.62oz of gold. Taking reserves into account, you get 4oz if you buy Goldcorp and 5oz from Eldorado – both US gold stocks. The analyst also had a look at locally listed Perseus Mining ((PRU)), which equates to 7oz.
“If [the analyst's] figures are even close to be correct,” suggests Gartman, “then the risk/reward has turned vehemently in favour of owning gold mining shares rather than spot gold itself”.
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