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TheStreet Open House

Value to Find in Gold Miners

NEW YORK ( TheStreet) -- Gold mining stocks are poised for a healthy run as gold prices gap up due to the Federal Reserve's latest quantitative easing program.

Large- and small-market cap mining companies have seen generous gains in share prices since the beginning of August as investors had anticipated so-called QE3 to come from the central bank, and analysts have said more increases could be in store.

"A lot of these companies are obviously cash-flow positive and it's all about where the gold price is," said David West, a gold mining analyst at Salman Partners. "If you're looking for healthy companies, obviously a very lofty gold price is something you're going to look for."

Gold prices for December delivery dipped $2.10 on Monday to settle at $1,770.60 an ounce at the Comex division of the New York Mercantile Exchange, but are up 10.4% since the Aug. 1 settlement.

The yellow metal surged last Thursday afternoon by more than $38 for one of its largest intraday year-to-date gains after the Fed announced an aggressive open-ended asset-purchase program.

Large-cap gold mining companies also have jumped since Thursday. Shares of Goldcorp (GG), Barrick Gold (ABX) and Newmont Mining (NEM) are up 7.4%, 6% and 8.6%, respectively.

Ron Stewart, an analyst at Dundee Securities, said if gold prices continue to move up, these companies would see more profitability as their operating margins open up.

"If we start seeing gold prices move ahead again, the operating margin opens back up and you get a lot more profitability out of the companies," said Stewart. "Similarly for higher cost operators or developers with large resource bases, relatively low-grade resource bases, the leverage that provides them -- the actual opportunity for those projects to scale in size and become compelling investments -- is attractive to the market."

Simply, the gold mining stocks provide investors with leverage to price performance on gold, which is beneficial as the price of the precious metal continues to rise.

The sector took a hit during the six months leading up to August, as operating-cost inflation squeezed company margins.

From Feb. 1 thru July 31, Goldcorp dropped 25.5%, Barrick Gold fell 33.3% and Newmont Mining shed 27.7%.

Stewart said gold miners had hit a peak in their operating margins a couple of quarters ago, but inflation on mining costs squeezed the margins and forced equities in the sector to sell off.

Moderate- to small-cap companies may also be worth a look for investors as their value may not rise as quickly as the more visible miners.

Royal Gold (RGLD), Franco-Nevada (FNV) and Allied Nevada Gold (ANV) have added 23.3%, 18.7% and 51.2% to their share prices since Aug. 1.

Allied Nevada Gold, for example, has tremendous upside, according to Stewart, because the company has a large development project that is relatively low grade in Nevada. He said the balance sheet is healthy, and the stock is price sensitive. In other words, the low-grade opportunity in Nevada allows investors to look at the company and say if the margin starts to open up -- due to precious metal prices rising -- then there is enough leverage for the share price to respond quickly to the upside.

Beyond upside benefits rising gold prices could have, Allied Nevada Gold currently is expanding its mining project. The company produces about 150,000 ounces of gold per year, and has said that the completion of mill to process higher grade oxide and transitional and sulfide mineralization would bump average production to 582,260 ounces of gold.

There appears to be investor value across the sector, but analysts suggest that once share prices of the -ap companies start to flatten, it may be wise to move into the small companies.

More people, on market-moving events like quantitative easing, jump into names such as Barrick, Goldcorp and Newmont because they are the most well-known brands. After those stocks hit a peak, it could be wise to head to the smaller companies because they may be undervalued relative to the broader sector as less people are aware of those companies.

Stewart said that this was the case after the 2008 financial collapse. After QE1, he said large-cap firms performed best in the short-term, but lesser-known and smaller companies actually outperformed over an 18-month period thanks to a constructive price environment of the commodities.

Gold mining stocks soared during QE1 -- the first stimulus plan implemented by the Fed after the collapse. That first period, which lasted from Nov. 25, 2008 thru March 31, 2010, saw Newmont, Barrick and Goldcorp shares surge by 71.5%, 76.8% and 79.5%. Gold rose about 36% in QE1.

These same names didn't perform well after QE2. Newmont dropped 14.1%, Barrick fell 6.1% and Goldcorp lost 10.5%. Gold prices gained 12.7% during the period.

"I don't think miners are fully hedged -- I think they learned their lesson -- years ago they were just fully hedged in their positions," said Yu-Dee Chang, chief trader at Ace Investment Strategists. "Now they're leaving potential upside, so that's why when gold rallies now the miners rally a lot too."

While gold's charge higher would benefits these miners, investors still must remain vigilant about operational challenges and other activities that affect the individual companies.

"Most of the producers have had company-specific issues that have caused their stock price to underperform," said Stewart.

Barrick Gold, for example, announced in July that the building of its Pascua-Lama mine would cost about $8 billion, which was an upward revision from a previous $5 billion projection. The adjustment led George Topping, an analyst at Stifel Nicolaus to tell Bloomberg in an interview that the increase was "outrageous."

Newmont has faced local opposition to its Minas Conga copper and gold project in Lima, Peru. Citizens and the government there have complained that the project would harm the region's water supply, according to MarketWatch.

Keeping specific company hurdles in mind, times ahead could be good for larger and smaller gold miners supported by the yellow metal, which could be poised for 12-month rally with an upper-level price of $2,300 an ounce, said Chang.

-- Written by Joe Deaux in New York.

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