INVESTMENT COMMENTARY — Gold Mining: Value Found Among The Ruins

A newly released study by Canaccord Capital has found value among the ruins of the gold mining industry, even though the firm believes that this beleaguered sector may be in for further weakness in the days ahead.

“Gold Mining — Value Found Among the Ruins,” analyzes six major producers, and also covers, in detail, the significant elements affecting the gold market and gold stocks. Author Larry Strauss is a geologist with extensive financial experience, including a 5-year stint as a commodity analyst with a major New York firm.

While Strauss urges caution when investing in gold shares, he believes that the recent plunge in gold prices has created “excellent long-term value” in the shares of several leading mining companies, including Barrick Gold, Freeport McMoRan Copper & Gold, Newmont Mining and Placer Dome. These companies are recommended as “conservative investments,” which should outperform the sector in a depressed market.

“In addition,” Strauss notes, “they still have sufficient leverage to the price of gold to participate strongly in a sector recovery and offer reasonable risk-to-reward characteristics.” He estimates that each of these companies has the potential to rally by at least 30%.

Barrick Gold is cited as having the strongest financial position; as a result, it is expected to weather a prolonged downturn in the gold market better than any of its North American peers. The company is in the midst of a restructuring program, which Strauss describes as “a bold, positive strategy” aimed at maximizing shareholder value. The program entails the early closure (by 1999) of five of its ten mines: El Indio, Tambo, Bullfrog, Mercur and Pinson, as well as an increase in gold production, to 3.5 million oz. in 1999 from 3 million oz. in 1997.

Barrick’s total cash costs are expected to fall to about US$166 per oz. in 1999 from US$208 per oz. in 1997. Strauss notes that the company’s hedging strategy and low production costs have insulated its earnings and cash flow from adverse gold-price impacts until the year 2000. Barrick is described as a “buy,” with a 12-month target price of US$24.

Freeport also was given a thumbs-up, mostly because of its huge Grasberg copper-gold mine in Irian Jaya, Indonesia, which Strauss describes as the largest gold reserve in the world. Gold production from Grasberg is expected to reach about 2.6 million oz. in 1999 (1.8 million equity oz.) from 1.7 million oz. in 1997. Similar growth is expected for copper production, which is projected to reach 1.7 billion lbs. in 1999 (1.2 billion equity lbs.) from 1.1 billion lbs. in 1997. These increases are made possible by the fourth concentrator mill, which is on target to be completed early this year, some six months ahead of schedule. On the downside, Freeport was found to have the largest debt burden (US$2.5 billion) of any of the companies reviewed in the report, though this concern is offset somewhat by Grasberg’s long mine life (31 years), as well as its excellent exploration potential. Freeport is described as a “buy,” and given a 12-month target price of US$38.

The report reviewed the growth prospects of Newmont Mining, which last year completed its US$2.1-billion merger with Santa Fe Pacific Gold, creating the largest gold producer in North America with operations in four countries.

This merger, coupled with Newmont’s internal growth, is expected to result in an increase in 1998 gold output to 4 million equity oz. from 2.3 million equity oz. in 1996. “Accumulate,” Strauss recommends, while setting a 12-month target price of US$36 for the company.

Placer Dome, Strauss writes, “appears to represent the best turnaround story of the group.” He notes that total production may rise to about 2.7 million oz. in 1998 from 1.9 million oz. in 1996, and he suggests that the increased production is likely to coincide with a sharp decline in total production costs to about US$275 per oz. from US$304 per oz.

Strauss rates Placer Dome a “buy,” based on the expectation of strong growth ahead; he set a 12-month target price of US$20. At the same time, he chastised the market for not fully recognizing the company’s achievements, such as last year’s opening of the 60%-owned Pipeline/South Pipeline open-pit mine in Nevada, among others. “This mine should contribute at least 510,000 equity oz. in 1998 at total cash costs of about US$75 per oz,” he notes.

Strauss cited a poor year in 1996 and ongoing concerns about the ownership of Las Cristinas 4 and 6 in Venezuela as the two key reasons why Placer Dome has not received full recognition for its recent accomplishments.

Rounding out the companies outlined in the report are Homestake Mining and Battle Mountain Gold. “Neither of these warrant a purchase of their shares at this time,” Strauss writes. “Their stagnant production profiles, moderate-to-high all-in production costs and lack of hedging strategies are likely to result in depressed cash flow and negative earnings at current gold prices through at least 1998.”