May 13, 2009

A Miner For The Misesian, A Royalty For A King & Sand You Shouldn't Let Your Kids Play In

So Why Own Miners?? The reasoning extends past the inflationary aspect when analyzing precious metal miners. The gold and silver miners are very undervalued because they go largely ignored by the mainstream (i.e mutual funds, money managers, etc) in addition to the fact I have a crystal ball that tells me precious metals will be increase a minimum of 3-fold over the next 5 years ( that is my conservative estimate, so if you think that’s nuts, it is best to just stop reading), which comes free those belonging to the Austrian school of thought!. Another added bonus is that their is a strong correlation between the price action of the secuirty and that of the underlying asset. On average they have 3:1 correlation, as in the miners will move 3X that of gold.

Miners also have relatively fixed variable costs over this time horizon ( NO! He didn’t really say that did he??). Yes if you can get past the ridiculous structure of the previous sentence, the mid-tier and senior miners have the costs of mining between 375-500/oz into 2014 or so (they can hedge a majority of input costs ,energy,etc). Of course I expect wage inflation and energy costs to rise after this period, but gold miners can hedge their cost of mining to a degree that makes it rather easy to forecast the cost of extraction going out 5+ years. OK, that’s enough defending my conviction towards this industry (even though it was with myself), I will briefly expand on my favorite gold miners, and a gold royalty company.

YAWANNA SOME A YAMANA!..(As Borat would say)-  I don’t enough time to go on an in- depth analysis to the degree that I wish, Bit I will briefly touch on all the various reasons I love this equity. Yes I am the first man to love a piece of paper! But seriously, not only does Yamana trade at a huge discount to its peers (P/B, P/E, EV/RESERVES, etc), but also is in the upper echelon in terms of production growth. Along with one of other miners, it will go from approx 800k oz in 2008 to 2m/oz in 2012.  This is hands down my favorite actual miner for superior management, unparalleled growth (in terms of valuation) and the general misunderstanding of operating activities, (They have been a large copper producer due to its prevalence as a mining bi product which came to about 36% of revenue in 2008), having copper as a % of revenue decline to 24%  this year and 18% in 2010. 

They will ramp up gold production from just 800k oz in 2008 to about 2m/oz by mid 2012. Although they will see their costs increase to about $450/oz from 375/oz during this time frame, the financial impact to operating margins is nothing worth writing home about. If you are in the camp that thinks gold will reach 2000-3000/oz by 2012, it is worth doing a simple math exercise. Assuming the average price is 2500 and 500 cost per ounce, the gross revenue per ounce = $2000 multiplied by 2,000,000 would be approx 4 Billion. Taking the conservative approach assume only $2 Billion is left after-tax. This is already greater than 25% of their market capitalization!

Royal Gold is similar the previously mentioned Silver Wheaton’s twin brother (except in the gold complex), except for one big negative (it pays income-tax)! That’s a joke in case you missed it. Royal Gold currently has 25 producing properties, 9 properties in advanced development, 24 that are currently being explored in addition to be extremely well capitalized and on the hunt for royalty purchases. They recently purchased a stream from Tech Conmico which they will acquire gold under $400/oz for the life of the mine. Though they don’t have quite the growth characteristics of Silver Wheaton, but have significant development projects coming online over the next 3 years. In 2008 they produced about 120k gold equivalent ounces (which includes 2m oz of silver, various base metals & potash) and a 68% operating margin. As some flagship royalties come-online and others near peak production, I estimate Royal Gold to produce somewhere in the neighborhood of 250k GEO by 2012.

Lastly, I want to touch on Canadian Royalty Trusts, in particular Penn West and Canadian Oil Sands. If your not aware, Canadian trusts will lose their tax exempt status soon, thus severely crippling the size of this industries dividend. As usual the market responded by overreacting, thus creating opportunities for those with their head on straight. Penn West is strictly a valuation play, not to mention the fact is still sports a 6%+ dividend yield. I am more intrigued by the latter (Canadian oil sands trust) for numerous reasons. For those unfamiliar with oil sands, it is basically oil mixed in with sand. The extraction costs are therefore much higher than industry average (in the case of COS, oil must be over $40/barrel to be profitable). But again, if you think oil is going much higher, the higher marginal input costs are far outweighed by the higher reserve base they can achieve. Oil companies involved with the oil sands trade at a discount (the last 6 months being a great example). This being said the current market price doesn’t price higher oil prices in the future in addition to ignoring a potentially enormous catalysts in their Synacrude project (which they have a 37% interest). In short, the oil sands is a niche in the oil complex that anyone who thinks oil is going much higher, should be bullish on. More on this topic to follow.

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