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.

Evaluating a Gold Producer

Whether you are looking for a small cap startup gold producer or one of the biggest names in the business there are several things you should look for when trying to pick out the right one for your portfolio.

The quality, composition, breakdown and accessibility of the assets owned by a particular gold miner are very critical; it is not simply about having x million ounces of reserve and y production. The market prefers certain types of mines over others and this will be reflected in the Price/Net Asset Value multiple that the market assigns to a particular company.

Size and production are the most critical when evaluating a specific mine or a producer as a whole. In general 300k oz of gold per year + would be considered a moderate sized mine, with 500k oz and above considered large. Mines below 100k oz of production a year tend to be looked down upon by the market since the economies of scale are not there and smaller mines may be more prone to production problems due to a lower quality of processing infrastructure because of the small scale. The life span of any given mine is based on its reserve base, some of the largest mines in the world can support 10+ years of production at moderate to high yearly production levels.

Location is a critical factor, mines based in politically stable regions such as Canada, U.S. and Australia are preferred to mines located in more unstable nations in Africa and Central Asia. There are several reasons behind this, first being that a stable country/government is less likely to social issues that could impact mining operations (such as were seen in Kyrgyzstan recently). A second reason is regarding infrastructure, constructing a new mine in a remote area in a developing country will most likely require transportation, power, water and communication infrastructure to be setup. These are additional projects which may further delay the completion of a mine. Finally, taxation risk is another concern. Certain jurisdictions tend to be more mining friendly from a tax perspective than others. Recently Australia released a proposal that suggest a very substantial mining tax hike which sent the entire industry in an uproar. Obviously the lower the company’s exposure to a jurisdiction likely to increase taxes the better.

The physical characteristics of a gold deposit also have an impact on the asset’s valuation and thus the company’s value. Grade is perhaps the second most important aspects after the size of the deposit. There are several ways of measuring the total gold deposit contained on a particular piece of property which can make it rather confusing at times. The most accurate measure is usually listed as proven and probable resources. These are resources that are confirmed to be present based on a feasibility study and are economical to extract. The Resources tend to be a broader term, and include deposits that may not be able to be mined currently at an economic profit and/or there are doubts on the grade (concentration) of the deposit. In general when you see a mine that has reserves that are close to the sum of reserves and resources then you know there is usually a limited upside from further exploration on that given property.

Grade is measured in grams of gold per ton of earth (g/t), logically the higher the concentration the better. This leads me to the structure of the deposit, essentially whether it lends itself to some form of open pit mining or underground/shaft style mining. As a rule of thumb you require about 0.8g/t as a minimum cut-off grade for open pit mining and 4-5g/t for underground mining. Generally open pit mines are cheaper, easier to construct and run, however environmental cleanup costs tend to be higher. Underground mines tend to require more complex engineering work and also run the risk of more safety incidents.

Another thing to consider when looking at a specific gold mine or a mining company in general, is the amount of by-product metals it produces. Metals such as copper, silver, and zinc are typically found near or with a gold deposit. Although these metals contribute to the company’s bottom line the market assigns a lower multiple to gold companies with a higher amount of by-product than ones with little to none. The reasoning behind this is that these by-product metals have a much lower price than gold, and that investors get a lower exposure to the underlying movement in gold prices since part of the company’s cash flows are coming from other metals.

When investors look to invest in gold producers many of them typically want a stock that will be strongly correlated with gold’s performance. One thing that should be considered is whether or not the company hedges its gold production. A gold producer usually does this by entering forward/futures contracts to lock in a future price at which they will deliver the gold to the counterparty of the contract. The logic behind entering these contracts is that it reduces the uncertainty surrounding future cash flows. A CEO would look very smart if he/she locked in future production at record high gold prices, however the opposite is also true; making commitments to deliver gold at a price which is below market price can be very painful. Usually investors prefer to see companies with little to no positions on their hedge books. This gives investors control over the direction they want to take on gold prices rather than leave it up to management.

These factors cover some of the most important metrics affecting the value of gold producers. In general one can find that the most renowned companies in the industry rank quite well amongst all these factors along with having very vast reserves and high levels of yearly production.

Digging up the facts on Yamana(YRI)

Investment Opportunity – Yamana(YRI)

Pro:

- Potential natural growth (without further acquisition) of reserves through exploration including a conservative doubling of Pilar’s reserves from 1.5 million to 3 million with up to 5 million)
o This will also serve to increase production in some of Yamana’s smaller mines, thus moving from small to medium sized mines. This may help to improve the market’s perception on the quality of Yamana’s assets.

- Reduction of reliance on Copper as a revenue stream as more Gold based resources come online between 2010 and 2013. This should serve to help the market to see Yamana as more of a pure play on Gold rather than as a diversified precious/base metal producer.

- Technical’s, trending sideways for the last month. Currently in the middle of its 2010 range (12.7 – 9.72; currently at 11.25). However has outperformed: Kinross, Goldcorp, Newmont, and Barrick over this same 1mo period.


- Dividend increase, whilst the dividend yield is not attractive enough on its own to warrant investment in the stock, this increase on the 5th of May is an implicit signal that management expects higher steady Cash Flows, this is accompanied by a better/improving cash position. However plowback is still high (.8623) indicating that management wants to grow this business, perhaps aggressively. This improving financial position should help to eliminate the need for further stock issuance.

- Dog of the industry, being at the bottom of the industry in terms of performance, with seemingly improving financials, and production volumes along with a shrinking reliance of Copper as a source of cash flow, the market may start to increase its support for the stock based on the overall outlook for the company improving.

Cons:

- Divestiture by major shareholders: 5.3 million shares by Pyramis, 6.1 million shares by Fidelity, and 1.1 million shares by Blackrock, and 100k by TD and 170k by Harris Bank (owned by BMO). This is somewhat concerning since Fidelity, Pyramis and Blackrock were some of Yamana’s long time institutional investors.

- Poor Gold Play, as it currently stands, Yamana has given investors very poor exposure to gold. It would appear that the stock has benefited very little in the past year from the appreciation in gold prices in the last 6 mo. If this relationship holds true then Yamana shareholders may stand to gain very little from the medium term bullish sentiment for gold prices. The same can be said for Yamana’s performance compared to Copper’s performance over the same 1 year time period.


- Historical inconsistencies with regards to targets, this may very well be one of the reasons that YRI is trading at a discount to its NAV compared to its peers. The CEO (Peter Marrone) assures us that 2010 will be different, since YRI is already on track for Q2 and missed Q1 targets by 10,000 oz only because of an earthquake in Chile. If YRI misses these targets, the impact on the share price will likely be very detrimental.

- Diversified asset pool, the fact that YRI has many lower capacity mines has been a problem since it can be perceived as ‘more headaches’ by the market. However within this lies an opportunity if YRI can indeed deliver on its promise and expand the production capacity on some of its mines. However as it stands now this is currently a problem.

- Exposure to potentially imminent tax royalty increases, after announcements made by Australia about the consideration of tax hikes, there is a risk that this may spread to South American countries where YRI operates (Argentina, Brazil, Chile). This is an industry wide problem as much as it would be a YRI specific problem.

Ford, a strong turnaround.

Ford(F) was beaten up very badly a year ago, when there was problem after problem with the U.S. auto industry. That was reflected in the share price, 52 weeks ago the stock was trading around $2.50, today the stock is over $14. Yesterday there was excellent news for both shareholders and debt holders as Ford received an upgrade from Moodys to B2. Also F has outperformed many of its competitors with regards to the quality of its product; it has exceeded the quality of Volkswagen, Chrysler and Suzuki(http://www.chicagotribune.com/classified/automotive/chi-jd-power-vehicle-dependability-study-031810,0,1477320.story). Its market share has also increased its market share up to 19.2% in March 2010 from 14.6% in 2009.

Possibly one of the things that I put the most value on is that Ford is bringing the new U.K. versions of the Focus and Fiesta to North America in 2011. This is significant because the Ford focus has been the best selling car in the U.K. for 10 years, and the Fiesta has also done very well in the subcompact class since it was debuted. Currently 7,000 Americans have pre-ordered the Fiesta. While the number is not massive, for a sub $20,000 car its nice to see consumers wanting to buy the car already. Pre-orders show that there is some hype around the release of the car, and this may bode well for initial sales of the car.

I feel that with enhanced quality control, and new successful cars that have been shown to have strong sales internationally 2010 will be a very good year for Ford. The destruction of Toyota's perfect quality image has done nothing but help Ford. Honda has also recalled several thousand cars. As the Japanese auto makers are no longer viewed as bullet proof, and Ford has increased its quality the gap in consumers mind's between the Japanese and North American auto makers has shrunk. With all of this Ford will make a very good investment for the rest of 2010 and well into 2011. As America starts to emerge out of this recession, individuals will likely increase spending on new cars. Ford stock in my opinion will hit over $17-18 by fall 2010, and by 2011 the stock may be well over $20.

Buffet in Santa Fe

Berkshire Hathaway, the company run by Warren Buffet is a conglomerate holding company based in Omaha Nerbraska. The company has holdings in a wide variety of businesses such as insurance (GEICO),retail, home furnishings, jewelry sales, newspaper publishing, as well as several regional electric and gas utilities. Berkshire has major investments in major corporations such as beverage giant Coca-Cola and US bank Goldman Sachs. Berkshire Class A shares are currently trading at $103,250.00 (US) and BNI is currently trading at $98.10 (US) (At Nov 20th, 2009).

Berkshire agreed to buy the stock that it does not already own in Burlington Northern Santa Fe (BNI). It had originally made a purchase of BNI’s stock in Jan of 2009. BNI is the second largest U.S. railroad company with over 6,300 locomotives and over 32,000 miles of routes. The company transports freight, such as coal and agricultural products, throughout the western United States. The deal was roughly for $26bn in cash and stock. (http://news.bbc.co.uk/2/hi/business/8349065.stm) Burlington has one major railway competitor, Union Pacific. After Berkshire acquired BNI the stock price went from $75 to $95, a 27% increase, on November 3^rd.

Coal transportation accounted for 23% of BNI's business in 2008. Consumer products accounted for 34% of freight revenues in 2008. Industrial products made up 23% of freight revenues in 2008. This includes, building products (lumber, plywood, etc), construction products (clay, sand, cement, etc), petroleum products (liquefied petroleum gas etc), chemicals and plastics and food and beverage (canned goods, perishable food, etc). Agricultural products were 20% of freight revenues in 2008[1]. This includes wheat, corn, soybeans, and barley along with other grains. BNI's network is positioned to serve the agricultural regions of the Midwest and Great Plains. The agricultural products segment has experienced growth recently due to the tremendous interest in ethanol fuel, which is derived from corn.

Although fuel costs could be a concern for a transportation company, railroads can benefit from higher fuel prices since they are more efficient than trucking in transporting various products. This tends to shift transportation demand towards railroads with rising energy prices, thus somewhat insulating them from their own rising fuel costs.

The deal was financed with $8 billion from JPMorgan Chase and Wells Fargo. Berkshire is paying roughly 1% to 2% above the London interbank offered rate (LIBOR). The cost of funding is minimized thanks to Berkshire’s AAA-rating[2]. It is impressive that a company has retained such a high credit rating especially when other major financial institutions have a lower credit rating, especially throughout the recent economic crisis (LIBOR is based on AA rated major London banks).

Berkshire delivers very strong and consistent performance over time; excluding the derivative and investment gains, Berkshire's operating profit in the third quarter was flat at $2.06bn. The company's revenue was $29.9bn, up from $27.9bn last fiscal year.

To make such a large acquisition given the current economic situation is a testament to Berkshire’s financial strength. Given the long term value investing done by Mr. Buffet we can most likely expect a long term holding of BNI by Berkshire.

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[1] BNI’s website

[2] Standard & Poor’s

GM is down, but is it out?

GM once an iconic symbol of American industry has now fallen far from its highs of the 1950s and 1960s. In 2008 GM was the world’s second largest automaker in sales. On June1, 2009, General Motors filed for a government-assisted Chapter 11 bankruptcy protection. It is the third largest bankruptcy filing of the world. It can be expected that there will be significant changes with GM as it undergoes this restructuring. Hopefully it will emerge a more efficient and effective company that will rival foreign auto makers that have become so successful.
Taxpayers in the U.S. will end up with a 60% ownership in GM, with the union, creditors and the Canadian government owning the remainder of the company. GM will be getting rid of Pontiac, Saturn, Hummer and Saab, this will hopefully serve to remove unsuccessful brands and help to alleviate GM’s infamous brand overlap. GM will also close more than 2,000 of its 6,000 U.S. dealerships by 2010. That could result in more than 100,000 additional job losses.
GM as of June 8 has been removed from the Dow Jones industrial average, a distinction it has held since 1925, this is a symbol of how the iconic auto makers has fallen. The company will be replaced by technology giant Cisco Systems (CSCO). The new GM will have $17 billion in debt, rather than the $54.4 billion it had outstanding as of March 31. The unions' new contracts with the company and underfunded pension funds will not be cancelled or removed. The most important thing is not that GM lays off some workers and makes one time sales of brands but rather it must strive to become more competitive and rethink its business model. If GM does not offer more competitive vehicles then it will have similar problems in the future. GM will have to create a niche for itself and specialize in it, something that other competitors will not be able to do as well.
Recently GM’s brands, Opel and Vauxhall have been fought over by Magna, Belgium-based financial investor RHJ along with other bidders. German Chancellor Angela Merkel expressed her regret at General Motors' failure to choose a buyer for its German unit Opel, and said that a decision was "urgently" needed for the carmaker's future(Reuteurs). The German government wants to be assured that Opel will not shed a substantial amount of its 25,000 workers. Berlin has made clear they want Magna to be the buyer and are set to provide 4.5 billion Euros ($6.4 billion) in state aid to make it happen. Magna remains the favored candidate as of now.
Depending on how this deal will go through it can have a substantial impact on the auto industry. Certain companies may become more powerful as others become weaker. A new global giant may emerge, or historical iconic names may disappear but it is without a doubt that this financial crisis has reshuffled the auto industry and hopefully the public will benefit from more efficient and competitive companies. GM needs to standout from the crowd with projects such as the volt which will also symbolize to consumers that GM is leading the way for vehicles of the future.

http://money.cnn.com/2009/06/01/news/companies/gm_bankruptcy/index.htm
http://www.reuters.com/article/newsOne/idUSTRE57L0KF20090823

Economic recap

This is an article I wrote to summarize a critical period in recent economic history.
An Economic Overview of 2008-09
The year 2008 was characterized by one of the most dramatic macroeconomic conditions on record. After initial expectations that the crisis would be contained to the financial sector of the leading economies of the West, its universal and global nature became evident as the year wore on. In spite of the widespread freeze of credit markets, the first half of the year was marked by a great deal of positive news for emerging markets and for key commodities, such as oil, which experienced substantial gains. The year began with signs of a modest slowdown in the US, triggered by the sub-prime woes and declining house prices as mortgage defaults soared. This depressed the dollar, which, in turn offered some prospect of improvement for the substantial US external deficit. Hopes were high that an effective policy response would serve to halt the emerging crisis; however, such expectations began to diminish as it became obvious that the original $168bn tax rebate in the US had a minimal impact beyond a short-lived stimulus. Furthermore, the all-around surge in commodity prices that saw crude oil hitting a record high in July 2008 and the subsequent inflationary pressures added to the economic pressure on the consumer.
The crisis soon entered a turbulent phase, reaching its peak in September, when increasing insolvency concerns led to emergency bailouts of several major financial institutions in the US and elsewhere. Of particular importance was the chaotic collapse of Lehman Brothers, which is now widely recognized as a major catalyst in the further deterioration of the situation. The policy responses by the US and European authorities ran into trillions of dollars of rescue packages, bank guarantees, and quantitative easing but did relatively little to boost liquidity or confidence in the world’s major economies. There was growing realization that the de-leveraging drive by financial institutions would be a long and far-reaching process; this was evident from the TED spreads (spread between a 3-month US T-bill rate and LIBOR).
The prospect of significant demand destruction ultimately reversed the prospects for commodities and the rising risk aversion changed market sentiment regarding emerging markets. Stock markets virtually across the emerging world crashed as they joined the global slide. The close of 2008 presented a grim picture of the key economies of the world in recession.
The Institute of International Finance (IIF) went as far as to predict a contraction of the global economy in 2009 by 0.4%. The US economy is expected to decline by 0.9% while the downturn will shave 2.9% off the UK GDP.
It would not be inappropriate to mention Mr. Madoff and his Ponzi scheme. Bernard Madoff was arrested on orchestrating the largest Ponzi scheme ever, potentially scoring $50 billion. The incident not only crippled Wall Street’s credibility but also showed potential leaks and inefficiencies in US regulation.
This year, 2009, is looked to with much hope and fear. Investors are asking, "Will the recession end, or will it continue?" I am certain that we will receive some positive surprises this year from the market, and perhaps the economy as a whole. The Bank of Canada lowered the overnight rate target by 0.5% to 0.5% and the Bank Rate is now 0.75%. "The Bank will continue to monitor carefully both economic and financial developments in judging to what extent further monetary stimulus will be required to achieve its 2 per cent inflation target over the medium term." (National Post) This should hopefully help the consumer find cheaper financing which should aid consumer spending.
Perhaps one of the most incredible events thus far in 2009 was the financial rally which started in early March. During the month of March, Citigroup Inc.’s share appreciated 127%, the financial sector appreciated 17% during the same period—something not entirely anticipated given how badly beaten up the stock was in 2008.
Consumer confidence in the US for the month of April so far has seen a tremendous improvement compared to the month of March. The final consumer confidence level is expected to be 30% higher than that of March (according to wwwdailycommercialnews.com), perhaps a good indicator that consumers may start spending again.