Prospecting for Mining's Winners
If Gold Prices Maintain Heights,
Even Less-Efficient Small Firms
May Offer Benefits to Investors
By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL
January 27, 2006; Page C1
With gold prices near 25-year highs, more investors are searching for stocks that could benefit if the surge continues, such as shares of small and midsize gold producers that haven't advanced as much as those of larger gold companies.
Many of these smaller mining companies are known as risky bets, because of high production costs and, in some cases, challenging pasts. That makes it a more difficult game for investors, though one with a potential big upside if gold stays at these high levels.
As gold prices have climbed, to $559.70 an ounce yesterday, investors have flocked to shares of the largest producers, such as Newmont Mining Corp., up 40% in the past year, and Freeport-McMoRan Copper & Gold Inc., which has soared 75%. Focusing on these companies has made sense: They sport the lowest cost of production, so every time gold jumps a dollar, these producers see added profits.
STRIKING IT RICH
Track the price of gold from 1981 to present.Some investors and analysts say gold is now expensive enough to enable even less-efficient producers to benefit. Some of these investors have been focusing on Bema Gold Corp., a Vancouver miner with a $1.7 billon market value, whose stock price has risen 29% in the past 12 months. Those with even greater risk tolerance are looking at Hecla Mining Co., a Coeur D'Alene, Idaho, gold and silver producer with a market value of $600 million that has fallen more than 14% in the past year. Yesterday, Bema closed at $3.70, up 0.82%, on the American Stock Exchange. Hecla shares closed up 14% at $5.02 in composite trading on the New York Stock Exchange.
On the heels of the recent acquisition of Placer Dome Inc., by Canadian miner Barrick Gold Corp., some analysts have pointed to Bema and other midsize players such as Eldorado Gold Corp., and Yamana Gold Inc., as possible takeover candidates.
"There's consolidation going on in the industry," says Bema Chairman and Chief Executive Clive Johnson. "The big companies aren't making major discoveries, and if the bull market continues you'll see more of it."
Some hedge funds that are focusing on these smaller companies note that there often is a delay between the rise of a commodity -- and an accompanying climb in the price of shares of the largest producers -- and the catch-up rally that follows among the smaller companies with more challenges. That is why small oil and gas exploration-and-production companies have rallied only in recent months, well after oil prices and the biggest companies soared.
Others are bullish on smaller gold players in part because new money, including that from central banks, investors from Persian Gulf states and individual investors, increasingly is looking for plays on gold. Meanwhile, demand for jewelry from emerging markets is on the rise and some worry about whether global gold production can keep up.
"There is significant positive momentum behind gold, with new investment funds reported to be investing across the board," says John Meyer, an analyst at London securities firm Numis Securities Ltd., who is a fan of a number of smaller gold producers.
The enthusiasm for gold could ebb if fears of inflation subside. And the smaller miners aren't exactly closing in on windfall profits. Hecla is using profit from higher gold and silver prices to fund increased spending on exploration. It had 12 years of losses end in 2002, a rough period for the business in which Hecla's former CEO, Art Brown, said the company was "close to bankruptcy."
Perhaps most important, high production costs make it difficult for many of the smaller players to record big profits. It costs Bema about $300 to extract one ounce of gold, according to Parvathy Krishnan, a stock analyst at Morningtar Inc. That is somewhat above the industry's average. Bema has gold mines and development projects in Russia, Chile and South Africa. It reported a loss in the first nine months of 2005, despite the rise in gold prices.
For the first nine months of 2005, Hecla's average cash cost to mine gold was $315 an ounce. By contrast, it costs GoldCorp Inc., one of the giants in the business, less than $100 to extract an ounce of gold, according to Ms. Krishnan. Bema says its production is expensive because it has big operations in South Africa, and the strengthening of the South African rand has pushed up production costs in dollar terms.
Gold futures yesterday fell $2.50, to $559.70 an ounce on the Comex division of the New York Mercantile Exchange.
Production costs also are rising because of climbing energy and steel prices. That makes it more difficult for many producers to see windfall profits. And it is somewhat harder to get environmental approvals to mine for gold.
"Gold prices will have to be very, very high for some of the companies to benefit," Ms. Krishnan says.
Bulls acknowledge the production challenges but say that gold is getting to the point that even some of the less-efficient producers will be able to make more money.
Companies like Bema that are expected to step up their gold production in the next two years may be able to spread out some of their production costs, potentially sending profits higher. Bema says it will produce almost 400,000 ounces of gold in 2006, but it expects production to increase to almost one million ounces in 2008, thanks to more gold coming from its Kupol mine in Russia, a low-cost mine. If it can boost production, but Bema's costs don't rise as quickly, earnings will jump, bulls say. The company says it locks in the price of about 10% to 15% of its gold reserves and resources, as a hedge as it builds new mines, but the remainder is enough to allow Bema to benefit if gold prices stay high.
"Production costs are rising in U.S.-dollar terms for many U.S. and non-U.S.-based companies," Numis's Mr. Meyer says. "But gold prices have risen far faster and further than costs."
Write to Gregory Zuckerman at gregory.zuckerman@wsj.com
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