7 Secrets to Profitable Gold Investing, Part 2

The field of gold miners can be a minefield for investors.

But like any challenge worth tackling, well-selected gold miners offer the promise of gains well in excess of price advances in the underlying metal. To aid that all-important process of distinguishing likely outperformers from the rest of the pack, let's continue our discussion of seven vitally important topics for Foolish consideration.

After clicking here to review Part 1 of this series, join us below as we learn how to decode economic studies of proposed gold mines and assess the likelihood of successful mine permitting.

3. Feasibility
With hundreds of companies to choose from, Fools have ample opportunities to select gold companies with assets at any stage within the development life cycle of a mine. Between the moment a property is first secured for exploration, and the declaration of commercial production, projects pass through life stages much the way an infant progresses to adulthood (sometimes it can take just as long!). Where in the development cycle one opts to jump in is often a matter of personal investment style -- with some targeting the sudden leaps that stocks can take as a quality discovery first comes into view, and others awaiting production for the onset of cash flow. By the time production begins, however, gold stocks typically will have already enjoyed a very profitable ride as that successful outcome increased in certainty, and so the ability to properly interpret the feasibility of a proposed mine project can mean the difference between good gains from gold ... and great ones! Of course, risk ramps up as you travel back along the development cycle, but then so does the potential reward.

Assessments of mine economics come in three forms: a preliminary economic assessment (or PEA) that typically considers a range of potential mine design configurations, a pre-feasibility study that moves a bit closer to a final proposal, and a full-blown feasibility study that typically serves as the blueprint for mine construction and planning. All three types are contracted by independent third-party consultants.

Feasibility studies assess the full range of factors affecting a company's final decision of whether to proceed with a given project, encompassing: optimal mining and processing methods, optimal project scale (expressed as daily "throughput" in tons of ore), initial capital costs for construction, operating costs, the estimated mine life (in years), recovery rates for each targeted metal (the percentage of contained metal that milling processes would extract), etc.

Importantly, the reports also typically convert mineral resources into the more reliable categories of proven and probable reserves. And of particular significance to investors, these studies estimate mine economics on the basis of several metrics that are price-sensitive (meaning they vary according to future long-term metal price scenarios). For investors who are comfortable projecting their own forecasts for future pricing, feasibility studies can generate powerful opportunities to invest in the valuation gap between the various metal price scenarios.

Let's dive into some examples to see what we're looking for as investors. Exeter Resource (AMEX: XRA  ) failed to impress my former colleague Toby Shute with its flagship Caspiche gold project, and the stock's dismal performance since that time supports his view. Recently, though, Exeter released a pre-feasibility study for the oxide portion of the orebody that overlies the much larger sulfide deposit beneath. The study assumes a long-term average gold price of $1,320, which is a bit elevated relative to prevailing assumptions, though still comfortably within my own forward price assumptions. Exeter foresees a robust internal rate of return of 34.4% over a five-year mine life, although the payback period at 3.2 years constitutes a sizable chunk of that period. The study calculates a net asset value of $330 million for the project, for nearly 87% of Exeter's present market cap. Enticingly, assuming the oxide mine goes into production, one could argue that the 34.5 million ounces of gold within the underlying sulfide ore (market value of $51.75 billion at $1,500 gold!), has received a stingy-looking market valuation of just about $50 million.

In some cases, projects that may have been marginal a few years ago at $800 gold can begin to look solid with gold above $1,500. International Tower Hill Mines' (AMEX: THM  ) Livengood project in Alaska carried a mediocre IRR of just 14.6% assuming $850 gold in 2009, but less than a year later the company updated the PEA to show a 26.9% internal rate of return at $950 gold. International Tower Hill Mines expects to release a pre-feasibility study during the fourth quarter of 2011.

As a parting thought regarding feasibility studies, I offer this reminder: Size doesn't matter. Investors can easily become enticed by truly massive gold projects like Seabridge Gold's (AMEX: SA  ) KSM project with its 38.5 million ounces of gold and 10 billion pounds of copper. But with an estimated IRR beneath 12% even with a $1,200 gold price assumption, KSM still remains a marginal gold project despite its mammoth scale. On the opposite end of the spectrum, junior explorer Kimber Resources (AMEX: KBX  ) touts an alluring after-tax IRR of 40.6% for its Monterde project in Mexico, and a payback period of less than two years (13% of a 15.5-year mine life) within a recently updated preliminary assessment. At just 744,000 gold ounces, Monterde would produce only a tiny fraction of KSM's conceived scale, but the economics are far superior.

4. Permitting
Like a determination of positive economic feasibility, the often arduous process of securing all relevant government permits for mine construction is another hurdle over which all gold projects must pass. As an investor, getting tripped up at this stage in the development process can prove excruciating. Just ask Fools like me who were long shares of Taseko Mines (AMEX: TGB  ) when the Canadian federal cabinet overturned the provincial authority's positive assessment to deny Taseko's permit application. Even as fierce opposition to the project from First Nations and environmental groups took to Canada's national stage just prior to the denial of permit, I found myself on the wrong side of that call. Fortunately, Taseko remains a highly attractive copper and molybdenum producer quite apart from Prosperity, and patient long-term investors may yet win their golden prize.

Nonetheless, the idea is for Fools to avoid the mistake I made with Taseko and stay on the correct side of anticipated permit application results. I encourage Fools to carefully research any vocal opposition to a given project and to ask themselves honestly whether any aspects of the proposal give them pause. I received an email from Robert Redford recently, asking me to oppose Northern Dynasty Minerals' (AMEX: NAK  ) Pebble project in southwestern Alaska. Even with its jaw-dropping cache of 55 billion pounds of copper and 67 million ounces of gold, Northern Dynasty must be deemed a very high-risk vehicle with that sort of grassroots opposition in play. Conversely, where projects have enjoyed harmonious consultation with relevant interest groups, and in jurisdictions where mining has long been a mainstay of the regional economy, Fools are more likely to find themselves on the right side of a permitting call. Mexico is one such permit-friendly jurisdiction for miners, so once AuRico Gold (NYSE: AUQ  ) releases what I expect will be a positive PEA for the Guadalupe y Calvo project, I envision an abbreviated process through the feasibility stage and onto construction.

In Part 1 of this series, we scanned the globe for some of the most prospective golden real estate that coincides with friendly geopolitical and regulatory settings, and outlined some key aspects of mineral geology. Here in Part 2, we touched upon some important characteristics to watch for within project feasibility studies and permit application dynamics. Click here for Part 3 of this discussion, where we learn how to gauge a miner's all-important potential to expand resources through ongoing exploration, assess the strategic health of a miner's development pipeline, and pinpoint management teams that possess the golden touch.

Click here for my recent gold series: Top 10 Gold Stocks for New Money Now.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of AuRico Gold, Exeter Resources, Kimber Resources, Northern Dynasty Minerals, Seabridge Gold, and Taseko Mines. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. 


Read/Post Comments (10) | Recommend This Article (27)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 12, 2011, at 12:22 PM, Jbay76 wrote:

    Sinch, this is really good insight, thanks! Have you seen the most recent AuRico release yet? It's really fantastic news!

    J

  • Report this Comment On July 12, 2011, at 12:29 PM, XMFSinchiruna wrote:

    JBay,

    Loved it! :)

    Those guys are really on an incredible roll.

  • Report this Comment On July 12, 2011, at 12:37 PM, XMFSinchiruna wrote:

    For those interested, check AuRico's recent press releases here:

    http://www.auricogold.com/index.php?option=com_docman&It...

  • Report this Comment On July 12, 2011, at 1:04 PM, Jbay76 wrote:

    Sinch,

    They really are on an incredible roll and I am sooooo glad I followed your article in the beginning of the year! I don't even know how BRD can match that level of productivity and low cash cost...simply amazing!!! :D

  • Report this Comment On July 12, 2011, at 2:56 PM, XMFSinchiruna wrote:

    JBay,

    Those are two distinct types of turnaround stories in the making. Gammon/AuRico was superbly positioned for a rapid recovery from its spate of prior pitfalls coinciding with a powerful acquisition, whereas Brigus is setting up as more of an organic growth story; although both are emerging from deeply oversold conditions ... the beauty of a well selected turnaround story.

  • Report this Comment On July 12, 2011, at 3:43 PM, Jbay76 wrote:

    Hey Sinch,

    That's good to know, and if BRD can trump AUQ...WOW!! Even if they go tick for tack....WOW. I am just really impressed with AUQ's report today and still on track to get some BRD in the immediate future, so I'm for both turn-around stories!

  • Report this Comment On July 12, 2011, at 5:12 PM, Gonzhouse wrote:

    Sinch,

    Great stuff. 1 question and 1 comment. The Question: the Feasibility studies get down to Internal Rate of Return or the value of discounted cash flows. On the revenue side, you identified the value of the metal/commodity as a big driver: agree. What about the cost side? The type of mining operation and the cost of reclamation efforts has to play a big part in the expense. Have you seen Feasibility Studies where that is an issue?

    The Comment: As a Taseko holder I, like you, was disappointed Prosperity wasn't approved in Round One. But looking back, I have to give Taseko mgmt some blame. They held a 'we aren't worried' position the whole time without acknowledging the level of opposition. I'm not impressed that they made no effort to alleviate the concerns until after the decision. I will hold on to Taseko because I think they will ultimately get Prosperity. But the ride could have been a lot smoother.

  • Report this Comment On July 12, 2011, at 6:08 PM, XMFSinchiruna wrote:

    Gonzhouse,

    Absolutely, operating costs constitute one of the most crucial metrics when determining feasibility. Costs are most heavily impacted by mining method, deposit depth, grade, thickness, by-product content, strip ratio, etc. Those cost metrics are also price sensitive, though, since higher gold and by-product prices can open up new areas of the defined resource to mining through a tweaking of the cut-off grade, and higher by-product credits can substantially reduce cash costs per gold ounce. I've never seen reclamation costs present a primary obstacle to a project's feasibility, but Hecla's recent settlement underscores how occasionally legacy liabilities can creep back in to impact mining costs retroactively. That's uncommon, but it can happen.

    I agree completely that Taseko's management let investors down, but on the other hand I'm not sure you'll ever see a mining company suggest they are concerned about a potential negative permit decision. Optimism is the default public message from most public companies. But I too am unimpressed that after a 17-year permitting process they could be blindsided in that way, which suggests that long development timeline was not utilized adequately to develop a more benign mine design from the outset. Even as a Taseko shareholder, I found myself growing quite sypathetic to the concerns of First Nations, and I feel there has to be a better solution than to fill an entire lake with mine tailings.

  • Report this Comment On July 13, 2011, at 6:28 AM, silvermind wrote:

    Sinch and JBay,

    I join with JBay - very glad I picked up Gammon/AUQ in January - glad it is my #1 holding! Up about 40%.

    Question for Sinch,

    I own a sizeable portion of the explorer GGI - Garibaldi Resources

    http://www.garibaldiresources.com/s/Home.asp

    (they have a lot of properties close to AUQ's Ocampo). But I'm in it for .50/share and it is about .29 now. I am considering selling Garibaldi and purchasing BRD. I think Garibaldi may take a couple years or more to get enough drilling results that raise the price. But it really has some nice real estate. Anyway - I think I may need to sell in April next year so I'm thinking BRD may be a better way to go. Could you see BRD going up substantially by April?

  • Report this Comment On July 14, 2011, at 9:16 AM, XMFSinchiruna wrote:

    silvermind,

    I can not offer specific trading advice, and even if I could, time-specific calls of that nature are not part of my investing methodology.

    I understand your predicament, as many junior explorers offer enticing opportunities for meaningful returns, although with associated timelines that are both extremely difficult to anticipate and often frustratingly protracted. In general terms, however, I will suggest that someone with a short-term investment horizon as you describe may wish to keep exposure to speculative exploration plays to a minimum. I own my fair share of early-stage explorers, but if I thought I might need to liquidate within the next year, my exposure to that segment would likely be lesser.

    I have peaked at Garibaldi before, but I do not know it well. The news flow looks light to me. I like to see a steady flow of positive assay results from my explorers, and at a quick glance I'm not seeing that here.

    What did they do with the 6m shares of Paramount (PZG) they received in that 2009 transaction? Those shares would have a present market value of about $20m, or about 1.4X the company's mcap. IIf they sold the stake, I would scrutinize how the funds were utilized, as that will tell you a lot about mgt. Dig around a little for me, and get back to me on my blog for follow-up.

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