I recently wrote an article in which I argued that investors should consider buying mining companies that are not yet producing but that will be soon, and that will be producing with very low costs. I noticed that despite the fact that gold miners dropped substantially in 2013, two companies – Tahoe Resources (NYSE:TAHO) and Klondex Mines (OTCMKTS:KLNDF) — were flat and up 20 percent, respectively.
In fact, Tahoe Resources is within striking distance of its all-time high despite the fact that the silver price is down more than 50 percent from its 2011 high, and Klondex Mines is trading at a multiyear high. These two companies were not producing in 2013 but they are now, with low costs. I think companies that will be producing with low costs starting in 2015 will also be good investments, and I am seeking them out and maintaining that they have an excellent probability of being winners in 2014.
One company that is already a big winner in 2014 that fits this profile is Golden Queen Mining (OTCMKTS:GQMNF). The company’s shares are already up more than 90 percent for the year, but I think the move could continue for the remainder of the year, especially if the gold price remains strong. Golden Queen Mining owns the Soledad Mountain gold and silver project in California. The company is on the verge of receiving the necessary permits to go ahead with construction, which should take 12-18 months. The company needs to raise slightly more than $100 million in additional capital so that it will have the necessary $120 million in order to build the mine.
Once construction is completed Soledad Mountain is going to be one of the lowest-cost gold mines (with silver offsets) in the industry, and as a result the economics are incredibly favorable. It is going to produce an average of 77,000 ounces of gold annually at an estimated “all-in” cost of just under $650 per ounce, including taxes (I am assuming a lower silver price than the company, reflecting market prices). That means that it will have an incredible $50 million in annual cash flow per year with a market capitalization of just $143 million. Even if management has to sell some of the gold production to a royalty company or dilute shareholders, the stock still trades at a small multiple to the mine’s future estimated cash flow.
The mine will be able to produce for 14 years (13 years at full capacity), and this assumes that less than half of its total resources will be mined. In other words it can potentially mine a lot more than is currently expected. The company calculates that the project is worth more than $500 million using a gold price of $1,438 per ounce, a silver price of $27.65 per ounce, and a discount rate of 5 percent. Even if we use a lower gold price such as $1,300 per ounce, a silver price of $21 per ounce, and a discount rate of 8 percent, the project still has a value of nearly $300 million, or nearly twice the company’s current valuation. As the company raises the final $100 million or so that it needs and as production approaches, I think this value will start to be priced into the stock more fully.
However, there is one snag in this almost perfect value play. A month ago, the Center For Biological Diversity filed a petition to potentially stop production because the Soledad Mountain region is one of just three environments in which an endangered snail lives. While the company has already received three permits that allow it to begin construction, we are now faced with this potential tail risk. While I don’t think there is a strong likelihood that the Soledad Mountain project won’t be built, this tail risk is very real, and for this reason there is a good possibility that Golden Queen shares won’t rise to reflect the true value of Soledad Mountain until this is no longer an issue.
Investors might be pleased to hear that Tahoe Resources faced a similar issue. Local villagers near that company’s Escobal Mine protested its construction, and some analysts and investors saw this as a real threat. This likely kept the company’s value down and made for an excellent buying opportunity. These issues often get resolved unless there is a major environmental threat. For example, Taseko Mine (TGB) has had trouble retaining the necessary permits in order to build its New Prosperity Mine because it would destroy a lake, which would both hurt the environment and upset locals. It is unlikely that the Shoulderband snail is going to cause that much concern, but you never know.
Therefore I think investors should limit their positions in Golden Queen Mining. But as a small mining company with a market capitalization of just $143 million, this should be a given regardless of the environmental risk. Given the political upheaval in Ukraine, we may not get what appears to be a much-needed pullback in the gold price or the prices of gold mining shares. Nevertheless, despite the opportunity I see, I think investors should wait for a pullback. If it doesn’t come, it isn’t the end of the world — a portfolio should never rest on one trade or investment.
That being said, there is little doubt that Golden Queen Mining shares offer incredible value right now despite having nearly doubled so far this year, and I think this is a near-term, low cost producer that will perform well in 2014.