Ride Yamana Gold to $30 and Beyond

By the time Yamana Gold (NYSE: AUY  ) reaches $30 per share, those of my readers who heeded my urgent plea three years ago -- when the stock fetched just $3.87 -- will have enjoyed a powerful multibagger ride. The rest of you have only to decide when you'd like to join in the fun.

As a reminder, I first posited my fair value estimate of $30 for Yamana Gold when gold traded near $1,200 per ounce back in August 2010. Thus, as gold hovers in strength here above $1,700, and ultimately catches fire to blow through my conservative forecast of $2,000 per ounce, keep in mind that my fair value estimate grows ever more conservative in nature. With Yamana targeting production growth of roughly 50% over the next couple of years -- driven by the addition of four new gold mines in Mexico and Brazil -- the reliable catalysts for further share-price gains are visible on the horizon.

Spotlight on Chapada
Yamana's Chapada operation in Brazil lies at the very heart of the miner's ability to deliver industry-leading by-product cash costs year after year, since massive copper credits more than offset the cost of gold extraction there. In fact, during the third quarter, Chapada's by-product cash cost came in at an astounding negative $2,045 per ounce! On the strength of that copper production -- 41.4 million pounds of the stuff during the third quarter -- Yamana was able to turn in a consolidated by-product cash cost of just $94 per ounce of gold equivalent. Larger competitors Barrick Gold (NYSE: ABX  ) and Goldcorp (NYSE: GG  ) handle their cost accounting a bit differently, but reported by-product costs per ounce of gold produced of $328 and $258, respectively. Ultimately, those by-product costs reveal little more about an operation than the fortuitous nature of its mineral composition, but when they're carefully interpreted, it is nonetheless instructive to consider the impact of by-product credits upon a miner's cash margin per ounce of gold or gold equivalent (lumping silver in with gold) produced.

To render my call for Yamana to surpass $30 per share safer still, Yamana continues to deliver on what I have characterized as one of the most attractive profiles for organic reserve growth in the industry. Following up on the exciting discovery in 2009 of the Suruca deposit near the company's Chapada mine in Brazil, Yamana's exploration team has come through yet again during 2011 with a new copper and gold deposit called Corpo Sul. The deposit already boasts a substantial strike length of three kilometers, and remains open both along strike and "down dip" (at depth). When the initial resource estimate for Corpo Sul comes out before year-end, look for attractive ore grades in excess of those from Chapada's main pit. Yamana also expects to release a feasibility study for the Suruca deposit by December, with an eye toward an additional 40,000 to 50,000 ounces of annual gold production beginning in 2014, giving investors a pair of potential catalysts to look forward to in the near term.

When I first offered my assessment of a $30 fair value for Yamana's shares, the Suruca deposit was just barely coming into view, while Corpo Sul represents a further bonus asset that renders my long-standing price forecast more conservative still.

The most underappreciated component of Yamana's fair value
On the surface, Newmont Mining's (NYSE: NEM  ) $2.3 billion acquisition of Fronteer Gold may look like the biggest gold deal of 2011, but Yamana's transaction with Goldcorp and Xstrata to place the Agua Rica project into the same joint venture structure that governs their shared Alumbrera mine may yield a full notional value that runs well past that lofty figure. As I explained here, the deal provides for Yamana to receive revenue from 65% of payable gold production until that attributable product stream reaches 2.3 million ounces. So in addition to the deal's $310 cash component, and Yamana's retained 12.5% ownership stake in the project, Yamana can look forward to booking revenue on 2.3 million of the 6.6 million ounces of current gold reserves at Agua Rica according to a stated formula.

At a prevailing gold price of $1,400 per ounce, I calculated that revenue stream alone at more than $2 billion, but what if the ongoing, competitive devaluation of the world's paper currencies were to trigger an entirely new environment for gold, where these seemingly alien prices form merely the baseline for a lasting shift in the very structure of the gold market? While many continue to cling to the notion that gold must surely collapse to pre-crisis levels -- commonly referencing the infamous 1980 spike or a "reversion to the mean" hypothesis as their principal guide -- I would counter that gold is far more likely to continue reasserting its time-tested monetary role within an impaired global currency framework. I would add, then, that gold is likely to surprise many a skeptic by the sheer permanence of its rediscovered value vis-a-vis the various unbacked and easily printed pieces of paper. Even if the long-term prevailing price of gold were to average just $1,700 per ounce before that gold stream is fulfilled, Yamana Gold's revenue from Agua Rica -- in addition to that derived from its retained 12.5% ownership stake -- would reach a cool $2.7 billion.

Here again, when I calculated my $30 fair value estimate for shares of Yamana Gold, Agua Rica remained an early stage development prospect with little clarity as to how or when it might come into production. Presently, the project is coming together with targeted first production around 2016, and Fools can begin to plug the project into their long-term models for Yamana's forward cash flow. If $30 per share was a foregone conclusion as of August 2010 -- as I maintain it was -- then that mark is a virtual shoo-in given the company's various achievements since that time.

Momentum maintained
To be sure, Yamana has proven a noteworthy outperformer among the gold miners over the past year. It was precisely one year ago that I insisted Yamana was preparing for liftoff, and since that time the stock has outperformed even my top stock pick for 2011: AuRico Gold (NYSE: AUQ  ) .

Yamana Gold Stock Chart

Yamana Gold Stock Chart by YCharts

As the above chart illustrates, Yamana handily bested the disappointingly flat performance of the Market Vectors Gold Miners ETF (NYSE: GDX  ) over the past year. Closest rival Agnico-Eagle Mines (NYSE: AEM  ) suffered a major setback recently, and will require some time to close the gap. Meanwhile, as I hoped they would, Yamana came through with yet another increase to its dividend announced this week to keep itself in the running among the industry's leading dividend payers. The company has seen cash flow from operations expand by 66% thus far in 2011 to reach $945, and now sits flush with a hefty cash balance of $570 million. With four new mines set to enter production before the end of 2013, and mounting clarity for further drivers of production growth in the years to follow, I now submit that my prior fair value estimate of $30 for Yamana's shares has grown excessively conservative. And if this bull market for gold and silver plays out as I think it's likely to do, you can hang your hat on a far higher figure. For the time being, however, $30 makes for a particularly easy target amid a sea of undervalued gold stocks.

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 Agnico-Eagle Mines, AuRico Gold, Goldcorp, and Yamana Gold. 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 (7) | Recommend This Article (30)

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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 November 04, 2011, at 11:30 AM, tommylad wrote:

    Nice article Chris. As the fiscal policies of this and

    other countries continue to deteriorate, gold will

    hold up well. Companies like Yamana will increase

    in value without a doubt. Could Yamana be included in the top 10 to 15 gold producers?

  • Report this Comment On November 05, 2011, at 10:54 AM, MoneyWorksforMe wrote:

    Great article.

    In my own rl account, I'm betting very heavily on Aurico...I have purchased stock several times around $10 on the dips...By the looks of that chart the correlation coefficient between AUQ and AUY appears very high, (roughly .9?). At the very least I expect Aurico to keep pace with AUY's stock appreciation going forward, especially now after breaking through some key technical levels (resistance is now solid support)....

  • Report this Comment On November 05, 2011, at 4:01 PM, johnybottom wrote:

    OK Sinchy,

    I'm doing my DD on Fire River Gold and am curious if you've given it any glance?

    Roughly 138 mil fully diluted shares at $0.36/share mkt cap = $50 million.

    Their Nixon Fork mine is expected to produce 50,000 oz gold next year. I've looked back at a lot of their old estimates on bringing this mine online and they've hit their targets pretty well in terms of cost and timeframe. They're now receiving revenue in the past few months.

    50,000 oz @ $1000 / oz would equate to mkt cap = free cash flow for next year. It seems amazingly undervalued.

    I haven't had time to grasp the rest of their mines/business - so I was curious if you have looked at them at all.

    Cheers - happy Fooling.

  • Report this Comment On November 06, 2011, at 12:03 AM, skypilot2005 wrote:
  • Report this Comment On November 07, 2011, at 7:14 AM, XMFSinchiruna wrote:

    johnny,

    I have looked into it a bit, but there's more I would like to discern regarding St. Andrew's decision to divest the operation in 2008, groundwater issues, etc.

    http://www.firerivergold.com/s/NixonFork.asp?ReportID=368220...

    "There is much speculation, but few facts known about the groundwater situation in the mine. The water level in the mine is known to fluctuate as much as 6 m in the spring after the snow melt.

    While the full extent of the groundwater significance is not known, the mine is taking several steps to manage groundwater inflows should they become problematic to the crystal ramp development ..."

    http://www.sasgoldmines.com/i/pdf/nrOct1007.pdf

  • Report this Comment On November 09, 2011, at 9:22 PM, skypilot2005 wrote:

    "On November 07, 2011, at 7:14 AM, TMFSinchiruna wrote:

    johnny,

    I have looked into it a bit, but there's more I would like to discern regarding St. Andrew's decision to divest the operation in 2008, groundwater issues, etc. "

    See page 3 of the PEA. No water.

    Sky Pilot

  • Report this Comment On November 09, 2011, at 9:35 PM, skypilot2005 wrote:
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