Graham:
I think you make a lot of assumptions (as we all do when trying to predict the future). Here is my take on some of what you said:
>1) the huge resource will never reach its full potential because almost if not all of any
>future increase in the resource has no hope of being mined in our lifetimes and its
>value will be primarily based on cash flow earnings plus a discounted value for
>earnings going forward.
While you are correct that the present value of a dollar to be earned 30-40 years from now is minimal, there are two ways they could approach mining Busang:
1. Mine it at 4-6 million ounces per year in order to keep the price of gold up, or
2. Ramp production up to, say 10-15 million ounces a year and try to get the future earnings out sooner.
A lot of unknowns will need to be worked out in order to determine which of these alternatives will maximize shareholder value.
The first alternative would generate the most earnings and cash flow over the very long term, but, if gold is like semiconductors, i.e., the cheaper it gets, the more uses you find for it and the more demand there is, then maybe alternatve 2 is the better way to go. If the demand for gold is highly price-elastic so that a small decrease in price results in a huge increase in demand, or if a relatively small decline in price will put a lot of the world's mines out of production, then ramping production might not cause that big a decline in price. Rather, it would shift production and profits from other places where costs are higher to Busang
Which alternative is chosen will also depend on how the various partners in this JV perceive their interests. I could see the Indonesians saying they want to keep the resource in the ground, especially if dumping it will cause the price to crash. On the other had, they have development needs, and those need to be financed somehow. Think of Saudi Arabia. I'm sure they would love to just keep their oil in the ground, but they have a lot of debt to finance.
>My own belief and this is shared by others is that the lofty multiples being enjoyed
>by Gold producers is going to come down possibly to low teens. The world is
>finding more and more gold and Busang is an example of this. Despite the fact that
>they have been saying for 10 years or more that we are using more than we are
>mining the price has trended down. Why because investors and central banks have
>been seling of to make up the difference. Just think what will happen to the price of
>gold when producers start pumping out more than their is demand for.
So many people try to predict the future by projecting present trends forward. The problem is, trees don't grow to the sky, and holes do have bottoms.
So much also depends on the price-elasticity the deamnd and supply of gold. If a drop to $300 an ounce would cause a doubling of demand while half the mines in the world would be driven out of busines, then I would expect an equilibrium to be found somwhere north of $300 an ounce. If the price elasticity is negative for demand (as in, investors dump it at lower prices because it is no longer a reliable store of value, but no offsetting industrial demand arises), then a price drop could feed on itself and turn into a rout.
I would very much appreciate it if someone could send me or point me to where I can find information about these issues.
Also, lower PE's do not necessarily translate into lower stock prices. Look at your aluminums or the auto makers. At cyclical bottoms, prices are low and PEs are high to reflect the cyclical bottom and the expectation of an eventual upturn. At the peak of the cycle, prices are higher, but PE's are low to reflect the coming inevitable cyclical downturn. I do not know if gold companies trade this way.
Finally, a lot depends on what the expectations for future inflation and instability will be when the gold comes out of the ground, since such fears are what motivate investors to hold gold. Right now, such fears are at a low, but it is debatable whether we can expect that to continue for the next 30-40 years.
Gold is disfavored now because the drop in interest rates and inflation have made future earnings flows from financial assets more valuable. But a lot of indicators are saying that the two secular trends of lower inflation and lower interest rates are coming to an end.
>Indonesia is a high risk country and democracy is lacking there. Resource
>companies in this situation tend give up some of their premium because of the risk. I
>believe investors are going to have a nagging fear that the Indonesians are going to
>snatch another piece of the pie down the road.
Although your concern that these fears will affect the stock price is certainly justified, I am more optimisticabout the political situation than perhaps you are.
My understanding is that Indonesia is a developing country. As its educated middle class grows, so will demands for democracy and an end to corruption. So I think Indonesia will eventually movve towards a more democratic and open form of government.
In any event, given the potential for instability in the country, I would rather be invested with Bre-X in a 45% partnership with Indonesian companies and charities than in someone else with a 90-10 split with the Indonesians. If they nationalize Busang, somebody is going to have to tell all the hospitals and scholarship programs funded by the Indonesian side of this partnership where those programs are going to get their money in the future and why the private Indonesian companies deserve to be stripped of their interests. If they leave Bre-X with nothing, somebody is going to have to explain to other exploration companies why they should spend any more time or money in Indonesia.
Had Bre-X kept the 90-10 split, all the money-grabbers would have had to do is rant about the evils of foreign domination of the economy and no one would have cared about the stealing of Busang from its owners.
What I have learned is that every stock has its cloud on the horizon: the one thing that, if it came to pass, would devastate one's investment. Netscape has Microsoft. The tobacco companies have the tobacco litigation. Bre-X has the Indonesians.
The bottom line is that I cannot predict the future price of Bre-X or of gold. All I know is that gold as an investment is disfavored right now, and Bre-X has the strongest fundamentals of any gold mining company I have seen. |
