The Remaining Bargains in Gold

Given gold's historic run in recent years, the persistent failure of Jaguar Mining (NYSE: JAG  ) to deliver on some lofty promises struck many hopeful investors like a cannonball to the gut.

On Wednesday, that cannonball lost half of its heft as the stock surged by as much as 50% in intraday trading. China's Shandong Gold Group has reportedly approached Jaguar with an all-cash offer of $9.30 per share, a full 73% premium above the stock's Tuesday close of $5.39. Jaguar acknowledged that it has received offers, but remained coy, announcing "a strategic process to explore alternatives to maximize shareholder value."

A trail of broken promises
Wednesday's stock surge tossed a welcome lifeline that's likely to rescue many longstanding Jaguar investors from deep-underwater positions, though my own ill-fated "outperform" pick on the stock in Motley Fool CAPS -- initiated way back in 2008 -- remains deep in the red. With Wednesday's boost, the stock has finally recaptured the level from its debut on the NYSE in July 2007, barely edging out serial underperformer Kinross Gold (NYSE: KGC  ) and future outperformer Agnico-Eagle Mines (NYSE: AEM  ) over the same period. Meanwhile, industry laggard Golden Star Resources (AMEX: GSS  ) has redefined disappointment by contrasting a 50% decline against a 160% increase in the price of gold.

Market Vectors Gold Miners ETF Stock Chart

Market Vectors Gold Miners ETF Stock Chart by YCharts. Jaguar's rocky road to partial redemption. Since launching its U.S.-listed shares on the New York Stock Exchange in mid-2007, Jaguar's stock has now turned slightly positive for the nearly 4.5-year period, versus a 40% climb for the Market Vectors Gold Miners ETF (NYSE: GDX  ) .

To best understand what went wrong with Jaguar, it's helpful to move the clock back to the halcyon days when the company was beaming with golden promise. Back in 2008, the company touted a massive pending growth spurt from its Brazilian mining operations that would carry production from the 115,000 ounces actually produced that year, to 700,000 ounces by 2014. Investors, myself included, drooled over charts like the one below from Jaguar's corporate presentation dated April 2009:

As of April 2009, Jaguar envisioned output of at least 165,000 ounces of gold in 2009, 223,000 ounces in 2010, 373,000 ounces for 2011, and climbing to at least 620,000 ounces by 2014. As it turned out, the company has yet to surpass the 200,000-ounce mark for annual production, as lingering issues at the company's Paciencia mill forced the company to lower 2011 guidance to about 160,000 ounces.

The trouble started in 2009 when Jaguar unceremoniously idled its Sabara mine, a move the company later made permanent without ever providing what I would consider an adequate explanation to shareholders. Massive shortfalls from the Turmalina and Paciencia operations followed in 2010, requiring a change in mining methods at Turmalina and a management overhaul at both mines. Despite the addition of the new Caete mine in late 2010, 2011 has brought yet more difficulty with "limitations at the mills" and a cash operating cost that surged to $886 per ounce during the third quarter.

Recognizing that mining by its very nature is fraught with daunting challenges and unforeseeable pitfalls, my aim here is not to castigate Jaguar's management team for the rough road behind it. The point of this stroll along Jaguar's trail of broken promises is to provide context for what has become the bargain-basement valuation of Jaguar's assets resulting from those persistent operational woes. And from the news of this reported offer from Shandong Gold Group, investors are witness to a key precedent within the industry.

A tale of future promise
For all the myriad troubles Jaguar suffered on the execution side, I remind Fools that those issues never reflected negatively upon either the scale or the quality of Jaguar's untapped gold reserves. To the contrary, while the market remained understandably transfixed by the company's struggling operations, a veritable explosion in the company's reserve base went relatively unnoticed. Not so for diligent Fools, however, whom I reminded in May of this year to view Jaguar as "an astounding bargain for a producer with 4.26 million ounces of gold reserves beneath its Brazilian properties."

Jaguar's Gurupi project in northern Brazil -- acquired from Kinross Gold in 2009 for just $39 million -- now holds gold reserves with a current market value above $4 billion! The average ore grade at Gurupi is lower than those at Jaguar's existing mines, but the project's meaningful stash of 2.3 million ounces of gold will have nonetheless played a very key role in attracting Shandong's unexpected courtship. With all the work undertaken to resolve issues at Jaguar's existing operations, and given the long-term productive potential of the newer Caete mine, I believe Shandong or any other potential suitor is likely to blaze a far straighter trail than the one behind it to reach some of the profitable production growth Jaguar envisioned several years ago.

Of far greater significance to precious metal investors at large, however, is the fascinating precedent set by this reported offer as it relates to the valuation of mineral reserves and the ongoing consolidation trend among metal miners. 

Does anyone out there know how to value mining shares?
If this offer carries a singular message to resource investors, it's that untapped mineral resources and reserves are just as critical to deriving fair value for mining shares as are the near-term cash flow and earnings metrics that typically drive near-term market sentiment. This won't be the last time we see a gold deal proposed at a 70%-or-higher premium; not only because competition for quality assets is likely to grow quite fierce, but also as a reflection of the market's longstanding failure to properly assess the value of mineral resource inventories within its process of price discovery. This is one reason I consider mining shares a far better bargain than bullion at this stage of the bull market cycle. Of course, forward price expectations for the underlying metals also come into play, and here again I perceive a market that has collectively and systemically failed to anticipate the most likely long-term price scenarios for precious metals.

I'll take it a step further and point out that even reliable exploration upside and exploration successes that have yet to find their way into a 43-101-compliant resource belong at the table among the many  factors to consider when assessing valuations of mining stocks. The market, I maintain, has failed to adopt such a nuanced approach to the industry at large, and therein lies the opportunity for long-term investors to find ultra-deep value where those failures are most evident.

Jaguar offers a fine case in point, since even the reported $1 billion offer equates to just $235 per ounce of gold in reserves. Newmont Mining (NYSE: NEM  ) , meanwhile,  coughed up $538 for every ounce of measured and indicated gold that Fronteer Gold had amassed before that deal. Although part of that disparity relates to Newmont's anticipation of further exploration upside on the acquired properties, the disparity is nonetheless punctuated by the fact that Jaguar is an established producer with three operating mines.

Claude Resources (AMEX: CGR  ) offers another prime example. Operating only a single small-scale mine that is expected to yield less than 50,000 ounces during 2011 at elevated operating costs, the miner garners little fanfare from an indifferent equity market.  But the market's assigned enterprise value of $264 million for the company enters purely ludicrous territory when the rapidly expanding scale of its high-quality resource base comes into view. With 928,000 ounces of high-grade gold indicated at its Madsen project so far -- and 921,000 more ounces of gold-equivalent at the bulk-mineable Amisk deposit -- Claude is quietly amassing riches that remain wholly overlooked by a short-term and earnings-obsessed equity market. Claude's combined indicated resource plus reserves total 2.26 million gold-equivalent ounces, resulting in an enterprise value of just $117 per ounce (excluding inferred resources!). Not even the company's eye-popping discoveries to expand the resource at its existing Seabee mine have managed to move the needle, and the result is a stock that I consider among the industry's premier bargains.

Quality non-producing explorers like Paramount Gold & Silver (AMEX: PZG  ) , with no current cash flow to offer, are routinely subject to even more pronounced failures by the market to realistically assess the fair value of mineral inventories. I believe that the studious Fool, who can accurately identify those assets most likely to advance into cash-flow generation by one means or another, could stand to make a fortune investing methodically in deeply undervalued precious-metal explorers.

Over time, the ongoing consolidation trend in the precious metals space will correct the persistent failure of the equity markets to adequately value mineral inventories among the explorers and miners of gold and silver. This week's reported offer by China's Shandong Group to acquire Jaguar Mining at a 73% premium marks another important step in that direction, but I urge Fools to mine the mining sector for similarly undervalued mineral inventories before the inevitable flurry of asset revaluations truly takes hold.

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, Claude Resources, Golden Star Resources, and Paramount Gold & Silver. 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.


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  • Report this Comment On November 18, 2011, at 1:49 AM, Sturmudgeon wrote:

    Thanks, Chris, for an outstandingly well-written analysis. And for the 'nudge'.

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