Higher Gold Prices = Big Potential in Junior Gold Stocks
-Momentum Public Relations-
The recent surge in gold prices is being noticed by investors. So far this year, gold pricing has moved upwards by approximately 20 percent. This surge has resulted in a buying spree of gold exchange-traded-funds (ETF) and some upward movement in share prices for a variety of gold mining concerns.
The big question is; how will the recent surge in prices impact the prospects of junior gold mining companies?
Current market realities are providing favorable conditions for gold prices to advance further. The external conditions are certainly favorable given many relatively weak major currencies, low oil prices, low returns on mainstream investments, and general sluggishness of the global economy. Historically, gold prices rise when currency falls and vice-versa. The balancing variable lies with prevailing interest rates. When interest rates rise investors are attracted to the yield and hesitate to hold, store and insure a commodity like gold.
Major stock indexes worldwide have declined, despite efforts by the various central banks to spur growth through lower interest rates. Back in 2011, stocks looked much more stable and appeared to be in full recovery from the declines of 2008 and 2009. In 2013, the Federal Reserve in the US signaled that the era of low-interest rates was ending, and investors moved away from gold.
GOLD – HISTORICAL PRICES:
Gold has experienced substantial price growth in the past 15 years, even when post-2011 declines are considered (see chart below). A few weeks ago, gold rose above its 200-day moving average of $1,130 per ounce and questions are being raised about the potential for further price growth that could mirror the rally that peaked at over USD$1,900 per ounce in 2011.
The fact that prices have moved up by 15 to 20 percent so far this year suggests that a sustainable price level of $1,300 to $1,400 per ounce is realistic within the next 12 months. It is entirely possible that the pace of the increases this year may leave the commodity vulnerable to profit-taking which could moderate overall gains. Most market observers believe that the perception of the safety of gold as an investment has returned and that investors who bought in 2012 or 2013 will stand to profit from the rising price of bullion.
IMPACT ON JUNIOR MINING SECTOR:
The current price of gold may cause some understandable optimism in the junior mining sector. However, it is important to underline that the usual business fundamentals still apply. Wise investors will continue to avoid being caught up in pricing euphoria and look at key metrics to assess the viability of each opportunity.
Mining companies with significant extraction operations will benefit in a big way from lower energy costs. However, energy cost savings is likely a temporary windfall. One important consideration is the fact that, if gold prices rise, or stabilize close to current levels, a mining operation with a fully loaded cost of extraction of USD$1,200 per ounce will become a cash-positive proposition in the short-term.
What factors could guide investors? We suggest consideration of two “rules”.
RULE #1: Assets & Grades
Investors still need to monitor the value of a gold producer’s assets project by project. There is no substitute for due diligence in examining the grade of the ore that is being produced and following company updates. Grades that are sufficiently high and can produce good margins at USD$800 to USD$1,000 pit shell will result in positive cashflows in the present market. By using the very conservative “pit shell method” to calculate returns, the scrutiny is on the mine’s engineering plan and not on statements by promoters.
RULE #2: PCM
The rule of PCM highlights three additional elements to consider when assessing the hundreds of junior gold plays as investment opportunities.. The three elements are people, cash, and margin.
Simply put, this means that there is no substitute for the careful assessment of the people who are involved in the venture and their experience, integrity, and expertise. Also, companies need to have enough available cash to sustain their CapEx in the face of short-term price volatility. If they do not have cash they can be put out of business quickly by a market correction or an unforeseen production challenge. Lastly, junior mining concerns that own some higher margin operations will have greater functional flexibility. When prices rise, higher cost operations can be developed while lower cost mines can provide a source of funds to balance the CapEx requirements for more speculative ventures.