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View from the North: Let's Talk About Gold

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"Gold," barked the CEO of a gold company to whom I recently spoke, "is a wild animal."

Most investors no doubt feel the same way about gold companies. With the market disruption of disgraced

Bre-X

and

Delgratia

, administrative screw tightening by third-world governments, a bullion price (US$325-ish) hovering near a low not seen since the early '80s (US$284), and deflation allegedly looming, why would anyone want to buy gold? Strangely enough, for the same reason you would buy any stock -- the three M's: money, management and moxie.

The economics for gold have been nasty for about a decade. The U.S. economy roared out of recession during the twilight of

George Bush's

reign at an annual rate of 3.9%, and has purred around 2.5% to 3% annually since. Inflation, the mantra for gold bugs, has, at least according to statistics, been vanquished. Central banks have been selling gold aggressively. With this full clip being mercilessly emptied into the industry's midsection, one adage remains true: Quality will out.

Price charts of the largest gold companies since 1992 reveal an interesting pattern: Against a punishing economic backdrop for gold that would make a '49er weep, a number of big, well-managed gold companies have prospered. Take

Freeport-McMoRan Copper and Gold

(FCX) - Get Freeport-McMoRan, Inc. Report

. Thrust to prominence during the recent Bre-X brouhaha, its colorful chairman, Jim Bob Moffett, is always quick to point out that if you want to own gold shares, own the lowest-cost producers. What a surprise, FCX.A just happens to lead the low-cost pack (1997 break-even cost US$160). After languishing around US$10 in 1991, the shares, while off their to-date 1997 peak of US$33.50, currently change hands for about US$26. And you can snag a US3% dividend yield to boot. Check the stats on

Barrick

(ABX)

,

TheStreet Recommends

Franco

(FN:TSE) and

Euro-Nevada

(EN:TSE) and you'll find it's pretty much the same story.

Of course no great gold company is immune. Barrick announced recently that it is shutting down about half of its mines, including El Indio and Tambo in Chile -- the jewels from Barrick's takeover of

LAC Minerals

in 1994. The hidden agenda here may be that ABX probably overpaid for these assets and the low gold price gives Chairman Peter Munk a way out of a situation that the company admits has been ugly. Norm Duncan, an investment adviser at

CM Oliver Securities

in Vancouver, likes what he sees and commends Munk for having the stones to 'fess up and deal with the problem. "I didn't care for Peter Munk before, but I've got a lot more respect for him today," he said. Duncan likes the fact that other lower-cost Barrick mines, such as Peirina in Peru, will be developed to take advantage of the US$50 production cost per ounce. Once the mine restructurings are completed by 1999, Barrick will have reduced its average cost from US$200 an ounce to US$150, perhaps even lower.

The gold "mystique" has changed somewhat since the

Bunker-Hunt

(remember those good 'ol boys?) days of the early '80s. The Bre-X fiasco and falling bullion price have been, unquestionably, cathartic. Should the gold price bounce around these levels for a prolonged period -- which is highly possible -- financing for junior golds will all but dry up, mines will halt production (or close) and weak, high-priced producers will merge, disappear or be bought at fire sale prices. Remember

Echo Bay

(ECO:TSE), the hot gold stock of the '80s? It's closing its office in Spokane and rumors are that Vancouver's next (1997 breakeven cost: US$480 ... ouch). If you were a banker, would you risk your commercial loan portfolio on a small or high-cost exploration venture in this environment? I think not. The loss of liquidity and a slowing of future production will likely keep the bullion supply in relative check. And for quality gold stock players, that's good.

But it must be noted that gold is no longer just a Patriot missile to inflation's Scud. Gold has developed an expanded role as an industrial commodity, and in our high-tech world the metal has no peer for conductivity and purity. Although rather small, micro-chip applications grow by 8% to 9% a year. Simply put, if it plugs into the guts of a computer, there will be gold on it -- and on any other electronic application that requires gold's one-of-a-kind attributes. The companies we should be looking for are those that can succeed in an unforgiving environment. With the gold landscape looking like scorched earth, the senior, low-cost producers are the way to go.

The TSE Gold subindex has fallen close to 30% -- to the mid-8000 level -- from 11,000 at the end of the first quarter of 1997. However, the price of bullion has dropped only 10% from US$355 in March. The sector looks ripe for some selective "nibbling." And I don't mean precious metals mutual funds. Do the homework, buy the stocks yourself, a bit at a time.

There are critical things to look for if you want to delve into smaller gold stocks. A good junior name mentioned here before (yes, at a higher price) is

Pangea Gold

(PGD:TSE). It has everything you should be looking for in a smaller gold play. Although a year and a half away from production, Pangea has C$20 million in the bank (which represents C$1 per share in cash of the C$3.50-C$4 share price). Its projects (Canada, Tanzania) are fully funded for the next four years through extremely strong joint venture partners (

Randgold

,

Anglo American

,

Ashanti

and

Placer Dome

, among others) and the company has potential reserves, so far, of 1.5 million ounces. And no debt. Projected cash costs per ounce should be low -- in the US$200 area -- and the CEO is a former top-ranked gold analyst, Jean Charles Potvin. It's definitely got the three M's. And the best part is that the share price got nuked post-Bre-X from about C$8 a share to the current level of around C$4.

And you thought there was no silver lining to that mess.

Bob Beaty writes about Canadian issues from the quiet venue of Bowen Island, British Columbia. He welcomes your feedback at

bbeaty@netcom.ca.