Speculative gold plays that could pan out: Dorfman

Most of these stocks are out of favor or risky bets -- but they might pay off in spades

Oct 25, 2010 @ 7:34 am

By Bloomberg News

It's not too late to buy gold stocks, even though the metal has gained about 21 percent this year.

The forces propelling the commodity's rise are still at work. These include:

-- Decreasing faith in the U.S. dollar. The Federal Reserve's program of quantitative easing will increase the U.S. money supply, making dollars cheaper.

-- International tension. U.S. investors fear Vladimir Putin, distrust Iran, worry about Islamic militancy, fret about the proliferation of nuclear weapons, and wonder whether Pakistan, Saudi Arabia and Iraq can maintain political stability.

-- Possible inflation. Although tame at the moment, inflation might rekindle if Uncle Sam pumps up the money supply.

-- Government gold purchases. Sovereign wealth funds in India, Saudi Arabia and other countries have been buying physical gold, pushing up the demand.

Liking gold is one thing. Figuring out which gold stocks to buy is another. The problem is that many gold companies sell for 35 to 70 times earnings -- if indeed they have any earnings -- thanks to the intangible psychological allure of this precious metal, and the strike-it-rich appeal of the idea that a mining company might make the next great gold discovery.

Attractive Multiples

Among U.S.-based gold mining stocks, the most reasonably priced is Newmont Mining Corp. It sells for a bit less than 16 times earnings, a multiple I can live with.

Based in Greenwood Village, Colorado, Newmont is the largest U.S. gold producer, operating mines in the U.S., Europe, Indonesia, Australia, and elsewhere.

Newmont largely disdains hedging, a technique for locking up a fixed price for gold to be produced in the future. So the company benefits more than some competitors when gold's price rises, and is hurt more when it falls.

After posting a loss in 2007, Newmont bounced back with profits in 2008 and 2009. This year, analysts think it will earn $3.91 a share, up from $2.66 last year. If they're right, it would be an impressive profit jump of 47 percent. Barrick Gold Corp., the world's largest gold producer, is more popular with analysts than Newmont. I prefer Newmont, which I see as somewhat cheaper and with a slightly better balance sheet.

Speculative Choices

In buying gold shares, many investors prefer to speculate on junior companies that are exploring for gold but not producing it yet. Some juniors will become producers; others will sell out to bigger players once they have proved the extent of their resource by exploratory drilling.

For speculatively minded investors who want to take a flyer on a less-proven company, consider High River Gold Mines Ltd., Inter-Citic Minerals Inc., and Victoria Gold Corp.

High River, based in Toronto, sells for seven times earnings before extraordinary items, and has a good balance sheet, with debt less than 6 percent of equity. It currently has two mining projects, one in Russia, the other in West Africa.

Last year its revenue, converted into U.S. dollars was $325 million, compared with $171 million in 2008.

Inter-Citic Minerals, located in Markham, Ontario, in Canada, is exploring for gold, copper and silver in China. The company has reported finding gold concentrations as high as 5.62 grams per ton of surrounding material in one zone of its flagship mine, the Dachang Gold Project. For open-pit mining, a concentration of 1 gram per ton or more is considered good.

Pockets of Gold

Victoria Gold Corp., based in Toronto, is trying to find gold and silver at half a dozen sites in Nevada and Canada. In September it reported finding isolated gold pockets with grades as high as 12 grams per ton at its Dublin Gulch site in Canada. The company stressed that it will not know the “true width of the gold zones” until it does further exploration.

Inter-Citic and Victoria both have small market capitalizations, which can make the stocks highly volatile. Inter-Citic's market cap is about $164 million while Victoria's is about $373 million. Victoria has had weekly moves up or down of at least 10 percent 10 times this year, and Inter-Citic has had such moves 13 times.

One way to acquire gold securities relatively cheaply is to buy shares in a company that produces both gold and base metals. A typical mixture is gold and copper, since the two are often found together.

Improved Earnings

My favorite gold-and-copper play is Freeport-McMoRan Copper & Gold Inc. Based in Phoenix, it mines the metals mainly in Chile and Indonesia. The stock sells for 11 times earnings, and analysts think earnings will rise to $8.28 a share this year from $5.86 last year.

Analysts, who disliked Freeport in the first half of 2009, have warmed up to it as earnings have improved. Their target price, or 12-month prediction, was about $50 in May 2009. Today their target is about $110. The stock trades at about $94 and I believe it has the potential to hit $124 by next fall.

[Disclosure note: John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. The opinions expressed are his own. Mr. Dorfman owns shares in Newmont, Inter-Citic and Victoria for clients and personally. He does not have any long or short positions in the other stocks mentioned in this column.]

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