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Equity Earning - Harmony Gold (HMY), Goldcorp (GG)



December 19, 2007 – Comments (3) | RELATED TICKERS: HMY , GG

Harmony Gold is selling a uranium asset for $252 million

I keep looking at gold stocks because I do believe in the merit of "gold is money," but something that seems fairly consistent with many gold stocks is that they aren't making money.  If you look at the statement for Harmony you see years of losses.  

Harmony is but one example of how I've seen these companies manage the finances.  They have a property, I have no idea what it cost them, but it is uranium and uranium is currently priced so there has been gross over investment in the area.  I didn't go back and check to see what the property cost them, but for sure it is a very nice equity gain.

The equity gain is going to show up in earnings and the 5-year bull run in uranium isn't going to be a repeatable form of "earnings."  So, they will have a spike in their "earnings," and this tends to hide the big, big problem that their ongoing operations have been losing millions of dollars, for years...

I frequently see this kind of thing when I start tearing into the financial reports on gold stocks, earning being proped up by equity sales, and then you get this insane belief or idea that a gold stock should trade on a high P/E multiple.  A year and a half ago my broker friend said gold stocks are valued at P/Es of 25.  Well, look at them now, Goldcorp is at a P/E of 110.  Interesting, I believe Goldcorp was around the price it is today when first studied Goldcorp and wrote about it in "How I Discovered the Gold Bubble."  I've since wrote about it in "Goldcorp: The Oxymoron of Fiat Creation."  In the latter I trace the financial reports to show how $6 billion of book value is created out of thin air.  It kind of reminds of the quality of the book value for mortgage backed securities and I personally don't see how it plays out any differently for gold stock investors. 

And, since I've written about Goldcorp they managed to sell and make equity gain earnings for two of their totally pig loser mines.  They also discovered an incredible gold vein in their Red Deer mine, something like $150k/ton, but it is a vein and most certainly will not support a $22 billion market cap.

And, I've also learned more about the history of Goldcorp that I did not know when I first wrote about it.  I guess just over 10 years now they discovered a vein with about 10 ounces of gold per ton, or 310 grams/ton.  That is metal values of about $8k per ton.  An underground mine is going to have mining production costs in the range of $50-100/ton, so no wonder Goldcorp is the world's lowest cost producer.  But, now that vein is pretty much mined and all that is left is a hole in the ground.  They have all of these new properties, but the gold grade is 1-2 g/ton for open pit, in the range of $25-50/ton of metal values.  I think the cut off for "economically feasible" underground mines is considered 3g/ton, or about $75/ton at today's prices.  That cut off doesn't make money.

As the high grade vein has been mined, the average grade Red Deer has been mining has been plummeting, and costs/oz has been sky rocketing.  Then they do the "gold equivalent" thing.  That is grossly misleading to investors.  When they quote things that way they are already counting all of the projected sales from other metals.  At one point their Alumbrea mine had about -$1600/oz production costs, mainly because Almubrea is more a copper mine than a gold mine, and they average the money from copper over the gold ounces and claim they are a cheaper producer.  It results in a copper mine being traded at that 110 multiple P/E.  And since copper declined and the quality of grade at Red Deer has fallen off a cliff, earnings have dropped from about 90c/year to about 30c/year.  Go back an look at the analyst's earning predictions from a year ago and their estimates were over by 100%.  If they had target prices of $30-40 then shouldn't they have adjusted them to $15-20?

And while I am at it, it is damn good snake-oil-economics to convince people that a grossly depreciating asset should trade at a leveraged P/E.  If they have a mine with a 10-year life-of-mine, well that means in ten years you have sold the asset and all you have is a hole in the ground.  It means your mining asset property is depreciating at a rate of 10% per year.  To my way of thinking, that means you need a P/E of 10 just to pay for the depreciation of the asset.  I know the make-me-rich-wallstreet-swindlers have all of these other methods of valuation that they throw out there, but when I contrast how they are doing it and how valuations were being done prior to the crash of 29, well, things like that creation of $6 billion of book value and the selling of equities through a bull market to pay for operating costs is the foundation of why the market crashed.

3 Comments – Post Your Own

#1) On December 19, 2007 at 2:42 PM, floridabuilder2 (98.07) wrote:

i'm done with gold stocks....  i haven't made a dime on them over the last 3 years when they shot through the roof....  I concur with your logic

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#2) On December 21, 2007 at 2:08 AM, abitare (30.11) wrote:

Good work on GG. I sold my GG stock after reading your overview.

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#3) On December 21, 2007 at 9:05 AM, dwot (29.11) wrote:

Yeah, I just don't see how it ever justifies its price and the typical way that people look at it is they see how much it has produced, how much they say they plan to increase and do a linear extrapolation. 

The problem is that in Red Deer the grade has rapidly been declining.  The grade they were mining about 4 years ago was about 2.5 times better than the grade they are mining today.  That means in order to keep up on the level of gold they were producing they have to make large capital investment to increase the mining rate, so say they were mining 1000 tons per day, now they need to mine 2500 tons per day to get the same amount of gold.  That just costs a lot more money, both in capital expenditure and operating costs.

The other thing that Goldcorp did for a few quarters in earlier years, I think around 2004 or 2005, was they didn't sell all the gold they produced.  Then when the price of gold went up, they sold for this one time big earnings and that is when Goldcorp went through the roof, at what about $45/share?  Maybe it was $44.  How does saving the gold and then selling it all at once to grossly pad the earnings for one quarter only do anything but grossly mislead investors?  Of course, that's when the insiders sold. 

The new vein they discovered will enable them to spike their earnings for a short term after they put up the capital costs to mine to it.

But something else that is amazing about Goldcorp is they convinced investors to cash in all their warrants and they managed to get completely out of debt and what are they doing now?  Paying for the new mine construction with debt.  Gold mines tend to have an average life of 10-12 years and they have about 10 mines operating, I haven't counted lately.  If they need to be replacing a mine pretty much every year to remain constant, they should be generating enough cash to pay for a replacement mine every year, not borrowing to do so.

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