There is no doubt that investors flock to gold as a safe haven hedge during times of political and/or economic distress and instability. And up until recently, the economic backdrop was about as bad as it could get. Furthermore, with the printing presses currently running overtime to fund ambitious government spending, a weaker dollar and runaway inflation could be on the horizon.
Rather than simply investing in physical gold, investors who really want to protect their portfolios need to look at gold miners. My absolute favorite miner is Goldcorp (NYSE: GG), based out of Vancouver, Canada. It is one of the world's largest and fastest-growing gold producers. The firm operates nearly a dozen mines, most of which are located in Canada, Mexico and Central America. Those sites contain over 45 million ounces of proven and probable gold reserves, along with 1.2 billion ounces of silver and large amounts of copper, lead and zinc.
What Makes Goldcorp the Best Gold Play Out There
Like all commodity producers, Goldcorp has zero pricing power and simply must accept whatever the market is willing to pay. On that front, the company is no different than its rivals. However, there are other factors that come into play...
When evaluating a potential investment in this sector, there are five main questions that should be asked:
1) How much gold is the company sitting on?
2) Is its reserve base shrinking or growing?
3) Where are the mines located?
4) What are its extraction costs?
5) And is production hedged or unhedged?
- Let's start with the first. With 45 million ounces waiting to be dug up, Goldcorp is the perfect size -- large enough to have reliable income, but still nimble enough for future production growth to really count.
- Better still, while some companies are facing a dwindling supply, Goldcorp is quickly replacing whatever gold it digs up. In fact, reserves have grown steadily larger for five consecutive years.
- Next, it pays to consider where a firm's mines and exploration projects are located -- those in certain parts of Africa, for example, carry considerable geopolitical risk and stifling labor costs. Fortunately, nearly three-fourths of Goldcorp's reserves are in stable NAFTA countries.
- Of course, cost is arguably the most important of variables. Clearly, if all producers are paid the same rate for their gold, then the winners are those that can dig it up for less. There too, Goldcorp comes out ahead of the pack.
In fact, the company can get gold from the ground to market for a total cash cost of just $305 per ounce. Others like Western Goldfields (AMEX: WGW) and Anglo Gold (NYSE: AU) pay closer to $500 per ounce. As the low-cost producer, Goldcorp rakes in much fatter profits for every ounce sold -- and it will sell over 2.3 million ounces this year.
- Finally, some companies choose to hedge their production, which can protect against falling prices, but tends to put a ceiling on profits when gold is rising. Goldcorp is unhedged, which means the company will be fully leveraged and gain the maximum benefit from stronger bullion.
By passing all five tests with flying colors, Goldcorp is clearly the industry's best-positioned senior gold producer.
A Little More Background on this Gold Miner
Goldcorp has come a long way in a short period of time. Just a few years ago, the company only owned a single mine, although that particular site (Red Lake) remains the largest gold mine in Canada and the world's richest in terms of ore concentrations. But recent acquisitions have transformed Goldcorp into a major player.
Since 2004, revenues have soared 13-fold, jumping from less than $200 million to nearly $2.5 billion. Over that same period, earnings, cash flow and gold reserves are up +107%, +149%, and +251% respectively, on a per-share basis. But Goldcorp's best days are still ahead.
There are really only two ways for a gold producer to boost revenues: sell more gold or get a better price for it. I think we'll see a combination of both, but let's focus on the one aspect that Goldcorp can control -- production rates.
Over the past three years, Goldcorp's reserves have more than tripled, climbing from less than 15 million to more than 45 million ounces. Meanwhile, the company is also pushing ahead with five development projects that will come online over the next few years. The most promising is Mexico's Penasquito mine, one of the largest precious metals discoveries in all of North America. The site contains over 17 million ounces of gold and over 1 billion ounces of silver, and commercial production is slated to begin next January.
Thanks in part to this and other projects in the pipeline, Goldcorp's future production growth will more than double that of rivals like Barrick (NYSE: ABX) and Newmont (NYSE: NEM).
In fact, management is planning to boost annual production from 2.3 million to 3.5 million ounces within the next five years. That +50% surge is unrivaled in the industry and will lead to superior growth rates for shareholders.
Goldcorp has the lowest costs around (with a profit margin of $630 for every ounce sold) and by far the industry's strongest growth profile. Plus, it also has the only net positive cash balance, with over $260 million in cash on the books and zero debt.
I think all the ingredients are in place for the company to churn out sustainable cash flows of $1 billion annually over the next five years. In time, the shares should rebound back at least to the lower $50s, which implies upside potential at least +50% from here.
Why It is Imperative That Your Consider Gold Miners
Back in April, I wrote about this very subject for Investor Update after the G-20 summit. Specifically, I said that all of this government spending would slowly but surely pull us out of the crisis and inflation wouldn't be far behind. But if things get worse, gold will still do well.
Not surprisingly, gold was the single best performing asset class last year. Gold spot prices have recently leaped ahead of future prices (a remarkable event known as "backwardation") for the first time ever. This is a reflection of the growing current demand for physical gold and widely interpreted as a prelude to a stronger upward move.
Aside from these near-term catalysts, there are reasons to be bullish longer-term as well. First, the world's 400 commercial mines only produce about 2,500 tons of the metal per year, yet the world uses over 3,500 tons. And while production has steadily shrunk since 2001, demand continues to grow (there are even signs that many central banks are looking to increase their gold reserves).
Keep in mind, even at spot prices approaching $1,000 an ounce, gold is still sitting at just half the level reached during the last boom in the early 1980s -- when it spiked to $2,186 in today's dollars. Back then, people couldn't sell their jewelry and other gold fast enough. This time around, it's just the opposite -- buying is so brisk that widespread retail shortages have been reported.
And if you're looking to amplify your exposure to rising gold prices, why not go right to the source? Whenever gold prices are on the move, shares of gold producers like Goldcorp usually behave like bullion on steroids.