Golden Days for Junior Miners

02/10/2006 12:00 am EST


Adrian Day

Chairman and CEO, Adrian Day Asset Management

When it comes to junior precious metals miners, few advisors are as experienced and knowledgeable as Adrian Day. Here, the editor of The Global Analyst looks at both Canada and South Africa for the best opportunities in the global junior mining sector.

"Given the overextended nature of the market and the probability of a pullback, this is not a good time to be chasing prices. We see the downside in gold is to the low $530s. As such, it’s still too soon to buy aggressively, and any buying should be selective. Put a toe in the water, but focus on companies that have some defensive characteristics (strong balance sheet, low cash costs, or low-risk business model). However, given the long-term outlook, one should not be too clever in trying to trade, particularly in solid, longer-term ‘core’ holdings. Here are seven factors to consider regarding your gold holdings.

  1. Gold is in a long-term uptrend, and we have only recently entered the second major leg of this bull market. The global monetary situation (think rising inflation and a lower dollar) and geopolitical situation have certainly not improved of late.
  2. This second leg up is more firmly based than the rise in gold from early 2001, when gold was largely the ‘anti-dollar’. Now gold is moving up in all currencies; and there has been a fundamental change in sentiment where negative news (for gold) is largely ignored.
  3. Gold remains fundamentally undervalued, relative to its long-term real (inflation-adjusted) price; to the money supply; to stocks; to oil…on any number of comparisons.
  4. Notwithstanding this, gold is short-term overextended; the recent rally has been too far too fast. A short-term correction should not come as a shock.
  5. Any correction will likely be relatively shallow and short-lived, given the strong physical buying from several markets (especially India and the Middle East), where buyers have quickly adjusted to higher prices.
  6. Although a correction is to be expected, we don’t know when, whether gold will fall $25 from here, now, or $25 from $600 next month.
  7. Despite the new highs in gold producers, they are still, as a group, selling right around long term average valuation measures. They are not particularly expensive, especially on an asset basis.

"In light of these factors, I would avoid the temptation to sell a quality stock now aiming to buy back at a lower price. There has been a sea change in the market, and it is important to think like a long-term investor not a trader. Thus for now, we would note, there are not many great buys on our list at present, but some solid ones for long-term investors. Moreover, there are several that we would buy on any weakness.

"We have seen advances on many fronts for  International Royalty Corp. (CA:IRC  Toronto). The Canadian company is not a pure gold firm, but has moved up in price recently both with the market and internal developments. Recently, there have been positive developments at two exploration projects on which International Royalty owns royalties, as well as additional micro-diamonds found on the Stornaway/BHP venture in Nunavit. 

"As the gold and resource bull market develops, we should expect more positive developments such as this on properties over which IRC holds royalties. In the meantime, Inco’s Voisy’s Bay nickel mine in Newfoundland should pay its first royalty check to IRC this quarter. We are very positive on the company’s prospects, and do not believe it is particularly expensive. We consider this among the best buys for those underweight in gold.

"Vista Gold (VGZ ASE), which is involved in mining operations from Canada to South America, has moved up in recent months along with gold. Higher gold prices validate Vista's model at its Hycroft, Nevada, project. Using $450 gold, a $25 million capital investment shows an internal rate of return of 29.5%. At today’s $550, however, a lower initial capital investment has an internal rate of return of almost 70%. Hycroft is a vivid illustration of the strength of the Vista model.

"With higher gold prices, many of its properties are now viable, with tremendous leverage. An updated study on its Paredones Amarillos project in Mexico, for example, which at $400 gold had a return of only 4%, now has an estimated return of 24%. This shows the benefit of keeping the ounces in the ground pending higher prices. Vista is fundamentally undervalued and is one of our stronger long-term holdings, with plenty of leverage to higher prices. Of the resource stocks on our list, best buy now is Vista Gold. For those underweight the sector who do not own the stock, anywhere in the mid to low $4.70s is a great price to buy.

"Firing on multiple cylinders, Altius Minerals (CA:ALS Toronto) is not a pure gold company, and, in fact, the stock has seen a significant correction from an early January run-up, retreating from a high of $5.20 to the current level, where it is a buy again. Altius is one of our favorite long-term holdings among the juniors. It is currently advancing several projects, including its gold and uranium properties.

"In addition, Altius has been short listed by the Newfoundland government for its innovative royalty financing proposal on the province’s Lower Churchill hydroelectric project. And its royalty on Voisey’s Bay will start generating revenue this quarter. In all, Altius has multiple prospective projects, in all of which it is taking innovative approaches which maintain its balance sheet. Buy on any weakness.

"Gold Fields (GFI NYSE) has clearly demonstrated the leverage that the South Africans have to a higher gold price and lower rand currency. Its latest quarterly profit was up sixfold, and particularly importantly, its production from South African mines was up with costs under control. Gold Fields continues its approach of diversifying outside of its home base, with just over half of its profit now outside South Africa. In particular, it has enhanced its beach head in Latin America.

"In recent months, it has made the go-ahead decision to develop a mine in Peru, which will produce about 2.3 million ounces over 15 years. And it has purchased Bolivar Gold whose project in Venezuela has exploration upside. We expect to see additional acquisitions in this region ahead. Though we like Gold Fields, with the best South African assets, a strong balance sheet, technically strong management, and growth, we would wait for better opportunities to buy."

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