Reminiscences of a Stockblogger

Oct 24

Week 16 Portfolio Update

I can’t believe how weak the gold stocks have been. While the price of gold has held up reasonably well, the stocks got pummelled yet again this week. Gold stocks seem to be reacting to each tick up or down in the price of gold as if their business was operating on the slimmest of margins. Yet nothing could be further from the truth. The gold producers are pulling in record margins, and should report record cash flow for the third quarter.

With that in mind I “leveraged up” on the gold stocks this week, buying a position in Barrick Gold on Friday (as it hovers around its 52 week low), adding to my position in Newmont, and re-starting a position in OceanaGold. I’m seriously considering trading out of Jaguar and into OceanaGold for no other reason than I am so sick of having the stock sitting on my watch list. But we will see if cooler heads prevail there.

I’ve also been listening to a number of interviews with Kyle Bass this week. I learned about Bass recently while reading an article about Michael Lewis’s new book Boomerang. Bass was one of the few that predicted and then bet on the subprime debacle. Lately Bass has had some very interesting things to say about what is taking place in Europe.

I’m happy to report that his views are not much different than what I’ve been saying since the beginning of August. That means that he also thinks the EU is unlikely to be able to deal with their debt issues in a sufficient manner.

Others agree. William Buiter, the Chief Economist of Citigroup called the EFSF a “pea shooter earlier last week”. Then on Friday night the European Commission released a report where they suggested private bondholders will be pushed to take 50 or 60 per cent haircuts on Greece.

All of the solutions being proposed right now are instances of the same basic idea. Layer on more new debt to pay back the old debt. How is this going to work? How is it going to appease the market?

Its the type of world where I am not comfortable owning much of anything, but it is one where I still have to believe that owning gold is a reasonable choice. Simply, how is it that we can have the second largest currency in the world under continued pressure and possible collapse, and it not be good for the asset class that is the “anti-currency”.

What’s more, it may be that the world’s third largest reserve currency is much closer to its own demise than anyone gives credit for.

Again, to the talented Mr. Bass (I just learned how to embed videos from CNBC so I’m all over that right now).

We might be on the verge of a far larger shift in the global reserve currency system than anyone imagines right now.

So I added a bit of Barrick at its 52 week low. I don’t want to get crazy or anything.

Oct 23

The Total Cost of Producing Gold

Last month I wrote a post about the second quarter results from OceanaGold . In that post I looked at the company’s assertion that the quarter was not as bad as it appeared on the surface because the total mining costs had not changed significantly. What had changed was that more of the costs were being expensed and less of the costs were being capitalized. Below was a chart I provided showing how OceanaGold’s capitalized mining costs had varied over the course of the last couple of years.

To generalize the point of that post, looking strictly at expensed costs (cash costs) as a judge of a company’s quarterly performance has its flaws.

So just to refresh, the difference between expensed and capital costs is as follows. Expensed costs show up on the income statement and factor into the commonly evaluated cash cost number for a company. Under most accounting methodologies these are the costs that can be directly attributed to the ore being mined. Capitalized costs, on the other hand, are hidden on the cash flow statement under the Financial Activities, usually showing up as Property, Plant and Equipment. They can be one time charges such as a new pinion bearing housing on the ball mill, or they can be pre-mining expenses such as the stripping away of overburden to get to ore that will be mined later.

While the expensed costs get all the headlines, the capitalized costs don’t get much attention at all. Yet both types of costs are equal in the place where it really counts: how the company’s cash balance changes from quarter to quarter.

The work I did for OceanaGold led me to wonder what the same sort of analysis would look like for other gold companies. What are the total costs of mining on a quarterly basis and how do they differ from the reported (expensed) cash costs that get so much attention from the brokerage community? What we are really interested in with any company is how much free cash they can generate. If a company is generating a lot of operating cash but is plowing that cash right back into the mine as sustaining capital, well then they are running on the spot. So total costs is what matters, be they lumpier and messier than cash costs or not.

Moreover I have to imagine that there is grey area when applying the criteria of what constitutes an expensed cost and what constitutes a capitalized cost. The implementation whatever accounting methodology is used probably varies from company to company. Simply looking at cash costs might ignore these discrepancies and paint a poor picture of what’s really going on in the operations.

To look at the effect of overall costs, what I have done is simply this. I took the cash costs stated by each company for the last two quarters and added to those costs the additions to property, plant and equipment as reported on their cashflow statement. Then I divided summation of these two costs by the ounces produced over the first two quarters. Because PP&A is likely to be more variable, it might be worthwhile to do this over a longer time horizon, but for now this will have to suffice.

This is an interesting result. It is particularly interesting when you compare the list against the same list of companies sorted on the more traditional cast costs metric.

What you see is that the companies that are lowest on the cash cost scale are not necessarily the lowest on the total costs scale.

Now of course, like everything, these results have to be taken with a grain of salt. One of the reasons that capitalized costs are not added to cash costs in for traditional analysis is because they are inherently lumpy. One time purchases that should be capitalized could skew the picture of the quarterly performance of a company. Brigus Gold is a good example of this. They are ramping up their underground mine at Black Fox right now. There are a lot of capitalized costs associated with that ramp up.

I went another step further by looking at costs for the full year 2010. That graph is shown below. Here a few of the companies (Lake Shore, Atna, Alacer, etc) drop off the list because they didn’t have comparable production for the period for one reason or another.

To make a few observations from the above graphs, the first being that OceanaGold does not look like such a high cost producer. While their cash costs are higher than the norm, their capitalized costs have consistently been lower than normal. I wonder how much this is caused by having a mature mine.

Another observation I would make is that Aurizon Mines truly is a (if not the) low cost producer. Both OceanaGold and Aurizon Mine are cash generators, which should serve them well over the longer term as they develop their mines.

A final observation is that B2Gold is worth taking a closer look at.

Oct 19

Sigh…Gold Stocks

A couple of misses and a couple of really bad days for my gold stock holdings. The fact that my portfolios are not down all that much is a testament to the power of cash (I am 55% cash at the moment), and shorts (while my banking short did not do well 2 days ago, they did quite well today, and I jumped on (off?) the Green Mountain Coffee bandwagon when I got a google alert yesterday morning about Einhorns presentation on the company (google alerts are invaluable tool in my opinion). I am up a good chunk on that short right now. Coastal has helped too.

But the gold stocks have been fairly distasterous. First a miss by Argonaut Gold, followed by an even bigger miss by Jaguar Mining. Aurizon Gold and Newmont didn’t miss anything but are respectively down 10% and 7%, presumably just for kicks. And with gold down another $16 tonight so far, I am afraid the carnage isn’t over.

Let’s start with Argonaut. I’m out! Look, I like Argonauts prospects but I don’t like the cash flow they are going to generate this quarter from a little over 12,000oz of gold sales, which is 5,000oz less than last quarter. With the stock being hardly down from its recent move up, I decided to break with the company for the moment. I will look at the stock again when the dust clears.

Onto Jaguar. I’ll admit that if Jaguar had been down 7-8% today I probably would have sold the whole thing and been done with it. But at 20% down it just seemed to me to be a little overdone.

I sold half my position in Jaguar back in September but kept the other half because I trusted management too much and it did sound in August like they were having a good quarter. So today was a bummer. It was frustrating to see them fall so terribly flat. The company has an “always something” complex. Its always a one off problem but its always something. However, I did buy back 1/3 of my original position today at the close. The reasons I bought were:

21% is a lot to be down on a single day. AEM shut a mine down today and it wasn’t down that much.
They still are going to produce a lot of cash for the quarter. They had 21.7M cashflow (0.25/share) from ops in Q2 on $60.6M of revenue. In Q3 revenue was $70M and costs were roughly $3.6M higher so cashflow from ops should be around $24-25M. Of course its all the higher gold price but cash is still cash.
While Paciencia sucked Caete looked like it finally turned around, and Turmalina looked fairly solid.
The assets aren’t that bad (they haven’t had a grade type issue yet where the gold is actually not there) and with the right management I think someone might want to go in and buy the company at this price. I mean you are getting total resource at less than $50/oz at this price.

Next is Aurizon, my as-it-turns-out-not-so-safe safe gold play. I used some of the proceeds from Argonaut to increase my position in Aurizon. Unfortunately it was a day or two too soon. I bought most of my position in the $5.40-5.50 range. Today the stock closed at $5.25. Sigh… I decided to go with Aurizon because they are really trading quite cheaply, they have around $1/share of cash on their balance sheet and no debt, and they should generate very strong cash flow in the 3rd quarter and going forward. The theory is that this will somehow help the stock during these take downs. Ha! Not today, Aurizon was down 7%.

As for Newmont, its just another instance of trying to keep some exposure to gold stocks (which may be the essence of my mistake here) while not taking too much risk (which is beginning to look like an absurd statement in this market). The stock has behaved pretty well, and low and behold it was down a mere 5% today. Sheesh.

I guess the reality the market is telling us is that in a banking crisis, you are much better off owning banking stocks then gold stocks. Clearly the losers of the collapse of fiat currency are the company’s who mine for the hard asset alternative.

Excuse the sarcasm.

Look, I am not going to get dogmatic here, and certainly not about gold. The market is saying what its saying, as insane as it might seem. I have raised more and more cash on every move back up (although never as much as I wished I would have raised in retrospect). I’ve tried to take advantage of the moves down to make trades like I did today in Jaguar and earlier this week in Aurizon. But its getting incredibly stressful to time these moves and deal with the volatility. Its wearing me down.

Probably the most frustrating part is how little time you have to get out when there is a move up. I swear that on Friday afternoon the gold stocks peaked within the last 15 minutes of trading. I pragmatically took money off the table. Problem is, usually I do this in stage. A little bit today, a little more tomorrow, gradually reducing the position down to a comfortable level. No such thing in this market. Friday afternoon the gold stocks peaked and on Monday morning most were down 5% within a few minutes of the open. Same with Tuesday when Jaguar moved up. I took a little off the table, but you have to do it all or nothing is this market, because as today is evidence, you just don’t get a second chance.

Oct 16

Week 15 Portfolio Update: Scratching Back to Even (again…)

My portfolio gained along with the rest of the market last week. The rollercoast on either side of par continues. The good news is, as the relative performance chart below shows, I have been outperforming the major indexes since inception.

Unfortunately the bad news is that I am still down 1% since I started the portfolio on July 1st. I’ve said on a number of occasions in the past couple of months that the best position to have in this market may be a cash one. Thus far that has turned out to be the case. Even though I have picked stocks and sectors that have generally outperformed the market, the fact remains that it is very hard to make money in a bear market without being short.

Speaking of shorts, I do want to point out once again that while I am not allowed to short stocks in the practice account that I post on this blog, I am short a number of stocks in my actual account. These stocks are entirely in the banking sector. Right now I am short BAC (Bank of America), UBS, and HBC (HSBC). I have been short HCG.to (Home Capital Group) but covered that recently on the suspicion that the market was going to rally. These banking shorts amount to about 1/3 of my longs, and they are there entirely as a hedge against the possibility of a systemic collapse brought on by some European catastrophe.

Also of note is that while I mentioned that I had began to buy Newmont this week, exchanging some of my gold junior shares for the shares of the gold senior, you will note there are no Newmont shares in the account displayed. I’m not entirely sure what happened here; I think I may have put the USD limit price for Newmont on the CDN dollar share order. At any rate, I didn’t get the shares I thought I got, and I didn’t realize that until I checked my portfolio this weekend. I’m not entirely sure what I am going to do about this now, as Newmont is a good 5% higher than when I had anticipated buying the shares. I think I will just sit in cash until the opportunity arises to buy the stock at the price where I actually bought it in my real accounts.

For the upcoming week, I would like to pare back some of my positions further if given the chance. D-day in Europe is coming up quickly, and god only knows what that day has in store for us. I have seen the market turn downwards on a dime too many times in the past couple of months to have any faith in the sustainability of this rally. If Europe actually comes to a workable solution, I will buy back stocks with a vengence, but until that time has clearly arisen, I will continue to exercise extreme caution.

The one stock that I might look at adding to is Atna Resources. I did a lot of work this weekend with another, more familiar, gold producer called San Gold. San Gold is an interesting story and I will try to write up a short piece on the company some time soon. I don’t anticipate buying and SanGold in the near term though; while the production and exploration potential of the company is interesting, it seems to be that a lot of this upside is already in the stock. Which brings me to Atna. What Atna has at Pinson seems fairly analogous to what SanGold had at Rice Lake before they began to ramp up production. Lots of high grade underground gold and a mill that was mostly commissioned and ready to go. The difference between the two companies is that Atna has a market capitalization of less than $100M, whereas Sangold at one time was a $1B company, and even now with recent production disappointments (which I have to say are not as disappointing as the share price performance would suggest) is a $600M company. There are differences to be sure, but nevertheless $500M is a lot of wiggle room to play with.