Mining for Gold...Mines, That Is

Joseph is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Over the past six months, the price of precious metals has been sliding downwards. In particular, gold has seen a drop of almost 25%, while silver has decreased in price by almost 33%; the devaluation has been rather dramatic in recent weeks:

   

In the period from April 9 to April 17, silver dropped more than 15%, to $23.34 from $27.51. Gold saw a similar drop from April 5 to April 15, with a drop of more than 13%, to $1371.67 from $1581.34 (all prices per troy ounce). No doubt, many factors are contributing to the drop in price, not the least of which is the rumor (recently confirmed) that Cyprus intends to sell a substantial portion of its gold reserves.

As goes the gold, so goes the gold mine?

Conventional wisdom has it that when the price of a precious metal goes up, disproportionate gains can be made by investing in the mines producing that metal. This would seem to make it desirable to own shares in gold mining operations rather than in the metal itself (as well as being more accessible to the average investor) -- at least, when prices are rising -- as increases in the price of gold represent a disproportionate increase in profit for the mines.

What happens when the price of precious metals goes down? Let's take a look at the performance of four mining companies:  IAMGOLD (NYSE: IAG)Eldorado Gold (NYSE: EGO)Goldcorp (NYSE: GG), and Pan American Silver (NASDAQ: PAAS). The following chart gives a fairly clear picture:

Data by YCharts

As the chart shows, the share price of these four mining companies has followed the pattern of the price of the metal they produce: for the last six months, they have dropped in value. According to the S&P / TSX Global Gold Sector Index (SPTSGD), which tracks 54 gold-mining companies, this pattern is pervasive, particularly during the past two volatile weeks.

Gold or bust?

The reason I chose the four companies above is that I uncovered them in a search of mining companies that were currently priced below their book value, and which displayed a set of characteristics chosen to loosely identify companies that were fundamentally solid. 

My thinking is that such companies would present interesting investment opportunities once the global precious metal regained stability, as there would be pressure to raise their price to at least book value, as well as the added value from the increased profitability of their product. Let's examine the four "selectees."

[Notes: The set of criteria, which reflect the characteristics mentioned, can be examined here. In the tables below, I refer to "Dividend Cover," which is determined by dividing earnings per share by annual dividend; a cover greater than 100% means EPS is more than adequate to pay dividends (I use this to replace payout ratio). Table data from The Motley Fool, other data from company websites. Clicking on the table of a particular company will take you to that company's website.]

IAMGOLD, a Canadian company, currently operates six gold mines and one niobium mine: the gold mines are located in West Africa, French Guiana, and Quebec; the niobium mine is located in Quebec. Four more operations are in various stages of development. The Sadiola and Yatela mines (W. Africa) are joint ventures, in which IAMGOLD has approximately 40% interest each. Its average cost per troy ounce produced is $715, with 830,000 ounces of gold produced in 2012.

Another Canadian gold-mining company, Goldcorp, has 12 mining operations in Canada, the U.S., Mexico, and Central and South America, with nine more projects in various stages of development. In addition to gold production, Goldcorp produces silver, copper, lead, and zinc from its mines. In terms of gold production, Goldcorp produced 2,396,200 ounces in 2012 at a cost of $874.00 per ounce (all products), or $638.00 per ounce (gold).

This Canadian company differs from the preceding two by virtue of the fact that Eldorado is focusing its mining operations in Europe (Greece and Turkey), China, and Brazil. Eldorado currently has seven mines producing gold, two mines under construction, and four more in various levels of development. In 2012, Eldorado produced approximately 660,000 ounces of gold at a cost of approximately $483.00 per ounce.

This Canadian company lays claim to being the second-largest primary silver producer in the world. Pan American Silver currently operates seven mines in Central and South America, with mines in Mexico, Peru, Bolivia, and Argentina, with three projects in development. 

As a by-product of its operations, Pan American also produces a small amount of gold. In 2012, Pan American produced 25.1 million ounces of silver at cash costs of $12.03 per ounce of silver, net cost after credit from by-product of 112,300 ounces of gold.

Evaluation

Certainly, Goldcorp brings to the table quite a bit of value: large operations located from Canada through South America; 12 active mines, and nine mines forthcoming; diverse production, including silver, copper, lead and zinc.

IAMGOLD and Pan American are somewhat less diversified, with the former producing niobium (albeit at separate niobium mining operations), and the latter producing gold (with the luxury of apparently using credit therefrom to reduce the overall costs of its silver operations). Eldorado is exclusively focused on gold. 

All companies offer comparable dividends, although IAMGOLD and Pan American offer larger yields; the dividends of all companies are well-covered by EPS. All companies seem equally well run, although IAMGOLD's higher production costs put it at a disadvantage as gold prices drop. 

In terms of price-to-book ratio, IAMGOLD represents what seems to be the largest discount, Pan American second, Eldorado third, then Goldcorp. However, a low P/B does not necessarily mean there is a lot of money to be made, particularly if the book value reflects some of the expenses that raise the price of operations. 

One should be careful about IAMGOLD's apparent discount. Oddly enough, although Pan American deals in silver, as its "golden" byproduct regains value, operational costs will drop faster for them than a rise in silver price would help Goldcorp. 

I find Eldorado's global presence to be a concern, rather than an endorsement, as they appear to be vulnerable to very volatile economic environments - even in China. I would focus my attention on Goldcorp and Pan American Silver, with maybe a side play on Eldorado if gold shows signs of coming back into favor.


Joseph Porter has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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