A New Look at Newmont

07/09/2004 12:00 am EST

Focus:

James Stack

President, Stack Financial Management

"Our strategy right now is to ‘hold the course’," says Jim Stack. "Our goal is to weather any volatility over the next couple months as the Fed implements its initial rate hikes and the market digests second quarter earnings." Here, he looks at Newmont Mining as a gold hedge.

"As usual, there’s a debate between those who think gold’s run is over, and the gold market bulls who believe this is just a brief pause in a long-term secular move toward higher gold prices. Frankly, we’re someplace in the middle. A number of analysts are quick to point out several reasons for exiting any gold positions:

  • Gold benefited in 2003 from a falling dollar, but pundits point out that the dollar has moved higher this year and predict it will continue to gain ground now that the Federal Reserve is raising interest rates.
  • Some analysts believe the gold sector is overextended after its big run. Although gold stocks have pulled backin recent months, the XAU Gold Index still has a whopping 74% gain since November 2001.
  • The gold sector is considered a contrarian investment. When the economy is growing and stocks are in a bullmarket, other stocks may appear more attractive and gold’s protective benefits take a back seat to other investments.

"On the other hand, we think the reasons to continue holding a gold hedge are still valid - and they’re more compelling. Let’s quickly review a few:

  • Although the dollar has rebounded this year, one should question whether this strength is sustainable in light of the growing budget deficit and a record high US current account deficit. Gold has historically provided an effective hedge against dollar weakness. We’d also point out that the latest rebound is still far from confirming a turnaround.
  • Gold has traditionally been an inflation hedge, and inflationary pressures are alive and thriving.
  • Geopolitical tensions are inevitable in this politically charged year. Although the handoff of Iraq has taken place, terrorist activities continue.

"While we don’t recommend holding a large allocation to the sector, a 3%-5% position in gold stocks or mutual funds is warranted as a hedge against currency fluctuations and unpredictable events. Our latest featured stock, Newmont Mining  (NEM NYSE) is the result of a three-way merger between Newmont, Franco-Nevada, and Normandy Mining in March 2002. Our original investment in this company was through Franco-Nevada, which was a well-run Canadian gold company with a hefty cash position and an anti-hedging philosophy. What set Franco-Nevada apart was its business strategy, which focused on owning gold royalties rather than hard mining assets. While this business plan proved highly profitable, growth potential was limited, as prime gold royalty investments became increasingly difficult to find.

"The merger of the three companies brought together the unique assets and business practices of each to create the world’s leading gold company. Since the 2002 combination, synergies have produced dramatic changes for the company. Newmont has significantly improved its balance sheet, reducing the debt-to-capital ratio from 41% to 17%, while building a cash position of $1.5 billion at the end of last quarter. Like Franco-Nevada, Newmont follows a no-hedging philosophy which keeps revenue leveraged to changes in the price of gold. In line with this strategy, Newmont has quickly closed out the substantial hedge positions which were acquired through the merger with Normandy. The new company has also successfully integrated key executives from both Newmont and Franco-Nevada into its leadership team, building on their diverse talents and broad experience.

"Compared to its peers, Newmont is now the world’s largest gold company in terms of production, market capitalization, and reserves. It has mining operations on 5 continents with 60,000 square miles of land in some of the world’s most promising gold belts. Last year, the firm produced 7.4 million ounces of gold or an estimated 9% of global mine supply. North America provided 39% of production, with 22% from South America, 26% from Australia, and the remainder from other overseas locations. We particularly like Newmont because of the diversity of its assets which offer some of the protection of a well diversified gold mutual fund, but haven’t weighed on the company’s growth or performance, as the key to maintaining its leadership position lies in its ability to maintain or grow reserves and production levels."

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