Consider Eldorado Gold for Geographic Diversification
With the gold price breaching $1,350/ounce, it is becoming more likely that we have seen a bottom in the gold price at $1,180/ounce. With this being the case, investors should consider buying some gold mining stocks. While you can diversify relatively easily by purchasing an ETF such as the Market Vectors Gold Miner ETF (NYSEARCA:GDX) or the Market Vectors Junior Gold Miner ETF (NYSEARCA:GDXJ), I think that you’ll do substantially better if you pick a handful of gold miners yourself using a few basic screening criteria.
- Buy companies that are growing their production.
- Buy companies that have low debt loads.
- Buy companies that are producing gold inexpensively.
- Buy companies that operate in relatively safe jurisdictions.
By buying a handful of companies that fit these criteria, you can build your own “ETF” that bypasses the pitfalls, and this should dramatically improve your performance.
One company that does a good job of meeting these criteria is Eldorado Gold (NYSE:EGO). Eldorado Gold has a $5.2 billion valuation. It is primarily a gold producer that produces approximately 750,000 ounces of gold rather inexpensively at $900/ounce before taxes, which means that at $1,350/ounce the company should have pre-tax cash flow of roughly $340 million per year.
While this isn’t cheap compared to many other companies in the sector, I should point out that for a large gold producer, Eldorado Gold has a lot of growth. It expects to grow its production to about a million ounces per year over the next few years, and it has the capital to do it. The company has $735 million in working capital versus $585 million in long-term debt, which means that it has ample capital to explore and develop its many properties.
In addition to having low production costs, growth, and a strong capital position, Eldorado Gold fills a unique role in most gold mining portfolios in that it has producing assets in unusual regions for the industry. If you look at the portfolios of many gold miners, you will see that they typically have a lot of assets in Mexico and Canada. They may also have some assets in the United States as well as West African nations such as Ghana, South America, and Australia. Eldorado Gold has more than half of its production coming from Turkey. Most of the remaining production is in China, and the rest is in Greece. The company’s near-term growth is likely going to come from its Greek Chalkidiki project which contains a whopping 10 million ounces of gold and 70 million ounces of silver. The company also has development and exploration property in Romania and Brazil.
For gold miners, these are unusual locations, and one could argue that it doesn’t exactly meet my fourth criterion that a gold mining investment should focus on low risk jurisdictions. However, while there have been some negative headlines in the news over the past few years regarding Turkey, Greece, and China, nothing has happened that should materially impact Eldorado Gold’s operations. The biggest threat comes from Turkey, in which we have seen social unrest and a weak currency. But the social unrest hasn’t hindered production at the company’s Kisladag mine, and the weak currency has led to a reduction in the company’s production costs in dollar terms.
Furthermore, while these aren’t familiar mining countries, I should note that they all have one key advantage that is lacking in Canada and Mexico — low corporate taxes. Turkey’s corporate income tax rate is just 20 percent, China’s is 25 percent, and Greece’s is 26 percent. These rates are low compared to Mexico, which has a 30 percent corporate income tax and a 7.5 percent mining royalty; the two taxes combine to create an effective tax rate of 35 percent!
Canada’s corporate tax rate is just 15 percent, but at the provincial level we find several other taxes including a corporate income tax — 10 percent in common mining jurisdictions such as Ontario and British Columbia, as well as a mining tax and royalty taxes to be paid to Native American tribes. So, for instance, the effective tax rate for mining in British Columbia is 41 percent! It is 36.5 percent in Ontario. When we look at these figures, we realize that while we may be unfamiliar with the mining practices in countries such as Turkey or China, the added risk is arguably cancelled out by lower taxes.
Ultimately, Eldorado Gold offers investors a way to get exposure to mines in unusual places. This makes it easier to add a little geographical diversification to one’s gold miner portfolio with just one stock. While this doesn’t justify owning Eldorado Gold shares, keep in mind that the company is a low-cost producer with a lot of growth potential and a strong capital position.
With that being said, Eldorado Gold may not be the best gold miner to own. It isn’t inexpensive and it does leave investors open to exposure to some geopolitical risks that they don’t often find with their other mining stocks. But as a fairly valued, diversified growth stock that will do well in a gold bull market, it makes for a solid addition to most gold miner portfolios.
Disclosure: Ben has no position in any of the stocks mentioned in this article.