De-risking gold producers

One can group the various risks of gold producers into two main categories: operational and developmental (for a detailed list see my previous article:http://morettooninvesting.blogspot.com/2010/06/evaluating-gold-producer.html) There are a few producers today that exhibit quite a bit of development risk although they are expected to have a relatively limited amount of operating risk when their projects eventually do come online. I will focus on two poster boys of the industry Detour Gold Corp. and Osisko Mining Corp. Both companies share many similarities, both have a single mine, both are located in Canada, both expect to produce 500,000 ounces of gold per year or more, and both will produce very minimal amounts of by-product metals. The main differences between the two companies are the following. First, Osisko’s mine has 8.4 million ounces of proven and probable gold reserves whereas Detour has over 11 million ounces in proven and probable reserves. The second main difference is that Osisko is expected to start producing gold in 2011 where Detour is expected to start production in 2013.

There are obviously pluses and minuses that one should consider before investing in a development stage gold producer. First and foremost is the risk of having any possible difficulties in the actual construction and setup of the mine. Failing to meet expected completion and gold production dates can show up negatively on share price. The market applies an even larger discount to companies such as Osisko and Detour who are undertaking their very first mine development project. The one thing that makes these companies very attractive is that once they de-risk (start actually producing gold) the discount disappears. The thing that makes these two producers more appealing than the average development stage gold producer is that aside from development risk, both companies will have very low operating risk. The fact that both companies have resources with very high gold concentration also helps increase their respective stock’s leverage to gold. Both companies also benefit from having low cash costs in the $400 range, helping to ensure that they will be able to generate positive cash flows even if gold prices turn south. Ultimately if an investor has patience and tolerance of mine development risk, these two gold developers can provide a very appealing alternative to a traditional large gold producer.

Goldcorp Mine Closure in Guatemala

Just today the Guatemalan government announced that the company must temporarily shut its Marlin mine during a probe into supposed environmental and human-rights abuses. This news comes surprisingly after the government stated over the past few weeks that there would be likely no need to shut the mine. No exact day for the closure has been sent and the president stated that he would give the company adequate time to close the mine. Most likely the closure will occur in 15 to 30 days. The closure has been prompted by the Inter-American Commission on Human Rights, which received numerous complaints from NGOs and local communities. The mine produces roughly 250,000 ounces of gold per year and 4.1 million ounces of silver which is approximately 10% of Goldcorp’s annual gold production.

“Guatemala is not going to close one of the country’s most important industries because of accusations that are probably based on anecdotal and non-scientific evidence,” said Patrick Chidley, a Stamford, Connecticut-based mining analyst at Barnard Jacobs Mellet USA LLC. The mine employs over 1,900 locals and pays a total of $21 million in annual salaries.

There are some key factors that one must consider when trying to think of the impact that this closure may have. First, shareholders of a large stable gold producer will not be happy to know that production will be temporarily stopped. This government intervention ultimately introduces the notion that Goldcorp’s mine might be located in a jurisdiction prone to policies that are unfriendly to mining. Now this is not to suggest that Goldcorp’s multiple will drop just like that however that may change depending on how protracted this closure becomes.

Guatemala has to be very careful on how it reacts in this situation for several reasons. The nation has a relatively low GDP per capita (approx $2,600, for 2009), and scaring away foreign investment is not really a luxury the country has. If anything I believe the country will deal with this situation in a reasonable and diplomatic matter, without causing too much of a fuss. Goldcorp on the other side will try its utmost to reduce the severity of any closures. However unlikely it may be, it would be very regrettable to see both Guatemala and Goldcorp losing from this situation.

As it stands I would hold-off from buying any stock at this moment until we see how serious the situation is. The stock dropped 1.12% on June 24^th 2010 after release of the news. However I would expect the stock to trade down a bit more unless of course gold has a very strong rally. For someone looking to get into the stock after a 12% gain since the beginning of the year this may be the perfect opportunity.