Gold bars are stacked in the safe deposit boxes room of the Pro Aurum gold house in Munich March 3, 2014.MICHAEL DALDER/Reuters
Sectors are often decorated with companies that have a common DNA. In the gold arena, most balance sheets are blighted with high debt loads. While that leverage can work during the good times with a strong gold price, when it falls, often they struggle. This is the current state of affairs in this field.
Many pundits regard the gold price and note that it is around the level of four years ago. This sends their senses into overdrive, particularly since that is approximately one-third less than the previous high. However, if a cursory examination is made of the five years or so when moving to the top, gold did about a quadruple in price. That is a huge move, exceedingly unusual for just about anything. The retrenchment after such a bold upstroke makes sense. Those enterprises in this sector that based their future on the party remaining in full swing were foolhardy. They should have enjoyed the gathering and reaped in profits while preparing for the more difficult times that always arrive. Instead, many bought competitors at ludicrous valuations and pasted their balance sheets with debts to be repaid.
One enterprise that contradicts the norm in this industry and was added to both Contra portfolios in December is mid-tier producer Alacer Gold Corp. The purchase price was from $2.01 to $2.06. If our crystal ball is correct, we will be unloading this position north of $6, better than double where it is currently trading. In the heat of the gold bubble, the stock price topped $12.
Alacer reported results last week. A major highlight was $347-million (U.S.) in the kitty with zero debt. Revenue this past year was $230-million. All-in-sustaining costs were $694 an ounce. That allows for a lovely high margin and full-year profit was $89-million. Insiders are well vested, owning over 20 per cent.
Being contrarians, we always are purchasing downtrodden stocks and naturally there are reasons they are beaten up. In the case of Alacer, the company lost money in four of the past six years. In 2012, the enterprise lost $386-million, which looks good compared with the 2013 drowning of $447-million. With numbers like that, many decided to drop this corporation down a mineshaft and run.
There are other reasons to be wary of this outfit. The company operates in Turkey, and though a favourable mining jurisdiction, that country is not high on the stability list. Alacer has only one mine, so those throwing money in this direction are effectively putting all their eggs in one basket. Management is relatively new, as many came aboard in 2012-13, so they do not have a lot of experience with this entity. Plus, the share count has better than doubled since 2009, broaching the 290 million mark. Management has indicated, though, that further share dilution is not in the cards.
Upcoming expenditures will be steep, with money being poured into the expansion of the Copler Sulfide Project, which was approved last month by Turkey's Ministry of Environment and Urbanization. This will extend the mine life, and the plan is that over the next 20 years, 3.2 million ounces of gold will be produced. The cost is anticipated to be about $660-million, which will mean negative cash flow for the company through 2017. That huge cash balance will come in handy, but even with all of the cash available, the dividend was suspended last week.
One reason in particular that we like Alacer is that it an attractive merger or takeover target. OceanaGold recently propositioned the company but was rebuffed. Other suitors could be circling, eyeing not only the mining possibility but the cash hoard.
Gold has held its own recently price-wise, particularly when the recent strength of the U.S. dollar is considered. At some point, the view of the United States as a bastion of safety will change – both the U.S. debt and the deficit are in very bad shape. In addition, its position as the global reserve currency will be strongly challenged and a basket of currencies will likely become more popular. When that happens, the greenback will probably weaken, pushing the price of gold to strengthen. From our perspective, that will happen before many years elapse.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter.