2 Miners To Buy, 1 To Avoid

By David Gould - October 9, 2012 | Tickers: ABX, FCX, NEM | 0 Comments

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Basic materials can make for some of the most uncertain investments. However, they don't have to. There are strong producers out there that are growing volumes and are able to appreciate in the absence of movement of the underlying basic material price. I recommend backing those miners and avoiding those that are being hit with multiple production headwinds.

Barrick (NYSE: ABX) & Freeport McMoRan (NYSE: FCX)

As one of the few pure gold plays left, Barrick particularly stands to benefit from growing fears over runaway government spending. Furthering this is the reality that the company has removed many of the gold hedges that it once had. In the near-term, I expect gold prices to stay high as macro trends in Europe and America continue to stagger. 

It is important to keep in mind that Barrick's income statement is directly dependent on gold spot prices while gold ETFs are dependent mostly on gold prices in the open market. By being able to extract at a lower cost, Barrick will thus be able to outperform gold ETFs - an attraction that the market has yet to appreciate. In 2011, for example, the company had an average cash cost of $460 per ounce at a production of 7.7 million ounces. Equipped with a large geographical footprint, Barrick further has reduced uncertainty. Their operations span five continents with proven reserves totaling 140 million ounces in gold, in addition to large stakes in silver and copper.

At the same time that the company has projects under development to add life to operations, there are numerous acquisitions to be made. An acquisition of the 50% remaining stake in Round Mountain, in particular, could unlock cost synergies by spreading out, and thereby diluting, fixed expenses.

Unlike Barrick, Freeport has significant relative exposure to basic materials outside of gold. In addition to having large room to increase copper output, low-cost production in Grasberg has been under-appreciated and, when volumes start kicking in, are likely to send multiples higher. Risk is not as significant as market commentators have made out given the firm's greater exposure to countries with investment grade ratings. Yes, copper prices have proved to be very volatile in the past and a significant amount has gone into the politically uncertain Democratic Republic of Congo; but, the company is still well diversified and can shift resources to ramping up production at ideal sites.

In my view, the company is well positioned following the board's decision to improve liquidity in the face of a low copper price environment. In just a few months following the global financial crisis, the company had shaved off $700 million of its $7.3 billion in debt. Debt has since fallen even more and become close to cash holdings. The reduction in risk coupled with rising production makes Freeport an attractive value play.

Newmont Mining (NYSE: NEM)

In my view, Newmont is worth no more than a "hold" right now. With around 100 million ounces of proven and probable gold reserves, the company has significant "wiggle room" around its site of operations. That is to say, if the political environment becomes uncertain in one region, Newmont can just send capital to other sites and help offset the "lost" production. But mining costs have risen while copper grades have started to deteriorate. The later results in yet lower margins from elevated treatment expenses.

On the positive side, I am optimistic about development of Hope Bay, which has around 9 million ounces in potential reserves. As the largest undeveloped gold site in the world, the upside is huge. However, Newmont's stock price has been rising despite the absence of a commensurate rise in volume. Accordingly, I recommend avoiding the stock for firms with stronger fundamentals.

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