If you think gold prices will soar, you want to consider owning an asset that is going to maximize leverage this price action. When I say “soar,” I don’t mean a rise to $1,500 or $1,750. I mean a rise to $2,500 or even $5,000, or perhaps even higher. If you expect this sort of price action, then you want to find a mining company.
In particular, you want to find a mining company that cannot operate profitably at the current gold price, but which can operate profitably at a much higher gold price. The benefit in such a company is that it will likely be incredibly inexpensive now, almost as if it were an out of the money call option. It has little value now, but if gold soars, it can be worth a lot — these are the sorts of investments, which, if chosen wisely, can make you wealthy.
If you’re looking for such a company, I think Seabridge Gold (NYSE:SA) is worth considering.
Seabridge Gold has a market capitalization of $425 million. The company owns a very large undeveloped gold resource in British Columbia called Kerr-Sulphurets Mitchell (KSM). It also owns some smaller properties, most notably its undeveloped Courageous Lake gold deposit in the Northwest Territories, although I will focus on KSM in this article, as it comprises the bulk of the company’s value.
Seabridge Gold is not a mining company in the strictest sense of the definition. Seabridge Gold is a prospect generator, meaning it operates under the assumption that building and operating gold mines require different skill sets than exploration. Prospect generators operate in various ways, but generally they find resource deposits and then find joint venture partners to develop them in exchange for some sort of compensation.
But unlike other prospect generators, Seabridge Gold has not found a joint venture partner for KSM, although it has been exploring the mine and building up its resource estimate for several years. It has no intention of developing KSM in the near future. It is waiting for “favorable market conditions” (i.e., higher gold prices). There are two reasons for this. First, the mine requires an incredible $5.3 billion in initial capital expenses to construct. Given the size and future cash flow of the mine, this is too much money to justify building it.
Second, management believes that the gold in the ground will maximize leverage to the gold price. In fact, on its corporate strategy webpage, it calls itself a “gold-in-the-ground ETF.” Of course, this is an over-simplification: The company does plenty of exploring, and it developed its KSM deposit to the point that the bulk of its resources are classified as reserves, which means that extracting them will be a cash flow-positive operation. But given the size of KSM, this is the best way to approach Seabridge Gold as a potential investment. A decision to buy Seabridge Gold shares is more or less an evaluation of the merits of owning gold in the ground.
This approach is appealing because mining is very capital intensive. Small mining companies often have to raise capital through secondary offerings or through sales of future gold production because they do not have the cash flow necessary to fund permitting or construction. While these investments might lead to scenarios in which the market revalues resources upward, the higher valuation is not fully appreciated by shareholders, who own less gold per share as a result of capital raises. Furthermore, these investments might end up being failures. Seabridge Gold seeks to minimize such risks.
Ultimately, as I have hinted at above, the KSM project needs higher gold prices to be economical to construct. If we are to value the mine on a discounted cash flow basis, then using a 10 percent discount rate, the mine doesn’t really become economical until we see a gold price of greater than $2,000 per ounce.
True, the mine will produce an incredible 850,000 ounces of gold annually for the first few years of its life and 500,000 ounces on average for the remainder of its life (more than 50 years!) at just $600 per ounce. But as previously mentioned, the mine’s initial capex cost is $5.3 billion, and if we are conservative and throw in unexpected contingencies, this figure can easily be $1 billion higher. If we are to discount the mine’s cash flow at 10 percent, it doesn’t exceed $6.3 billion until $2,000 per ounce.
And even then, the mine isn’t worthwhile to build — what’s the point of building a mine for $6.3 billion if it only yields $7 billion in discounted cash flow over the next 50 years? There are simply better investments. However, once we start looking at much higher gold prices, such as $3,000 per ounce or $4,000 per ounce, we begin to see sizable revaluations of KSM and Seabridge Gold shares by extension.
For instance, at $4,000 per ounce gold and a 10 percent discount rate, the mine’s value skyrockets to nearly $10 billion. That means that if the gold price (roughly) triples, Seabridge Gold’s value rises nearly 25 times in value!
This is why if you believe the gold price will soar, and I mean really soar, then Seabridge Gold is for you.