After the gold rush
Gold stocks have paid off handsomely. But will the good times last?
The worst is over for Chris Mitchell. Like virtually all small mining exploration outfits, Orvana Minerals Corp. (TSX: ORV) suffered nothing but misery and woe over the past five years, leaving Mitchell’s 85,000 shares and 650,000 stock options comatose. Don Mario, its only property of note, has lain dormant since the 17th century, when it is believed to have been mined by Jesuit missionaries who smelted its copper to cast church bells. A bare hill surrounded by subtropical forest 350 kilometres east of Santa Cruz in Bolivia, it seemed destined to remain that way. Mitchell resigned as executive vice-president and CFO at the end of September 2000. But he continued to look after the beleaguered firm, along with two Orvana officers and directors, even after he moved from Vancouver to Denver to accept a job at another mining company. Their patience has paid off: in an industry where the winds of fortune change abruptly, Orvana was bought earlier this year by a Bolivian firm that hopes to be mining gold at Don Mario in early 2003. “We knew we had a good asset; we worked for nothing to protect it for awhile, and hoped that would make our stock options become good eventually,” says Mitchell. “And that’s ultimately what happened.”
Similar jubilation is common across the gold exploration sector, thanks to an industry-wide updraft created by the rising price of gold. In this year’s Investor 500 list, 26 of the top 50 firms (ranked by one-year return as of May 3) came from the mining business. Most of those were small gold exploration firms like Orvana, whose stock price spiked 630% and captured the No. 2 spot. Others in the top 10 included NovaGold Resources Inc. (TSX: NRI), Fort Knox Gold Resources Inc. (recently renamed FNX Mining Co. Inc., TSX: FNX), Minefinders Corp. Ltd. (TSX: MFL), High River Gold Mines Ltd. (TSX: HRG), Bema Gold Corp. (TSX: BGO) and Cambior Inc. (TSX: CBJ).
The mining rally has been so strong that one mutual fund, the Vanguard Precious Metals Fund, recently closed to new and existing investors who were cramming it with money. The fund’s administrator, the Vanguard Group, based in Valley Forge, Penn., said it had grown concerned “about investor time horizons and expectations.” Another US fund manager, Jean-Marie Eveillard (co-manager of the First Eagle SoGen Gold Fund), made an even more ominous observation: “I have the feeling that the high-tech guys had in 1999,” he told The Wall Street Journal recently. Is this a buying opportunity for gold exploration stocks or yet another nonsensical bubble? The answer depends heavily on how robust the recovery in the gold price actually is—and, of course, your appetite for high-risk investments.
Many financial advisers warn strongly against any attempt to time the market, but timing is everything in the exploration business. Looking back at Orvana’s history, that lesson is evident. The company was founded in 1987 by former employees of Placer Development Ltd. (now Placer Dome Inc.), who struck out on their own to explore for new properties in North America and Jamaica, and planned to find joint venture partners who could bring them into production. Their timing was unfortunate: the Black Monday stock market crash on Oct. 19 that year held up their initial public offering. The founders “lived hand to mouth” for five years, Mitchell says, until a surge in gold prices renewed investor interest in 1992. That year, Orvana went public through the reverse takeover of a dormant TSX-listed company and began exploring in Bolivia. Though many of its expansion attempts failed, one purchase proved farsighted: Don Mario, bought from Bolivian, Dutch and Texan investors for US$21 million in 1996. “That is really what saved this company’s bacon,” says Mitchell.
When Mitchell joined Orvana in 1996, the company was just coming off its zenith. Its stock price stood at $8, down from an all-time high of $11, and its market capitalization amounted to $360 million. Don Mario seemed poised for production. But then the winds of fortune shifted yet again. The resounding implosion of Bre-X Minerals Ltd. in 1997 (amid accusations of massive fraud) cast a pall over the industry. To even more devastating effect, gold prices headed into a protracted slump. Many explanations have been put forward. Among them: central bankers in most industrialized countries were selling off their gold reserves, and gold companies were selling gold forward in long-term contracts (generally called hedging), which served to drive prices down. There are even more esoteric theories, such as a massive conspiracy among international financial institutions to keep gold prices low. Whatever the reasons, gold dwindled to as low as US$254 per ounce during the fall of 1999.
Declining metals prices leave exploration companies in a dead calm. Even senior producers have difficulty mining profitably, and the resulting reduction in exploration for new properties triggers an ugly spiral. Robbed of growth prospects, exploration shares collapse, which makes it ever more difficult to raise money. Orvana began its tailspin in 1997; by 2001, Don Mario had been mothballed, and all salaried employees had been laid off. Obtaining new investment was not possible. “Everybody wanted to be in dot-coms; nobody wanted to be in junior precious metals,” says Mitchell. “It didn’t matter how good your property was, there was just no investor interest. We used up all the money we had raised, and we couldn’t raise any more, so it was a matter of hanging on.” But even maintaining a skeleton crew to protect the camp (US$8,000 a month) and paying annual fees to keep the property concessions (about US$50,000 a year) became prohibitively expensive. By the end of last year, Orvana had less than $9,000 in the bank. Accordingly, its stock traded at a paltry 15¢.
In a last-ditch effort to salvage Don Mario, Orvana’s guardians changed tack. The company lacked sufficient resources to form a joint venture, but selling Don Mario or merging with another firm were two possibilities. Even in this, they were not in a strong bargaining position. “When you’re in a falling market, there’s just no incentive on the buying side to do a deal,” Mitchell explains. “They just take their own sweet time, because three months from now the seller is going to be even more desperate. We got into that trap.”
Orvana did, however, have a property that could be brought into production rapidly—and a feasibility study suggested it would be viable if gold were selling at US$300 or more an ounce. That was attractive to Compania Minera del Sur SA (Comsur for short), Bolivia’s largest private mining company. It now operates five base metals mines, but also had a gold mine near Don Mario, called Puquio Norte, that was approaching the end of production life. As a result, Comsur could transfer its own operating staff to Don Mario instead of hiring expensive expatriates. The two parties struck a deal last September. After the agreement was finalized in January, Comsur bought a controlling stake in Orvana for US$4 million, and installed CEO Jaime Urjel and new directors. Comsur also agreed to transfer US$8 million in equipment to Don Mario from Puquio Norte and lend US$6 million for further equipment purchases.
Comsur hopes to bring the new underground mine into production by next March, and the estimated 1.2 million tonnes of high-grade ore should keep it running for six years. While Comsur will continue to focus on base metals, Urjel hopes that Orvana will become its “vehicle for growth” in the gold sector. Orvana’s loans will be repaid to Comsur over a 60-month period, he explains, which may allow it to explore the land surrounding Don Mario, and elsewhere. Compared with Orvana’s situation a year ago, he says, “it is not an exaggeration to say that the contrast is like night and day.”
Comsur’s timing was impeccable. Since the deal closed in January, Orvana’s stock has shot to a recent high of 96¢ in late May (and subsequently backed off to a recent close of 63¢). The gold price is again a dominant factor. Gold began 2002 at just less than US$280 an ounce, but has since increased to as high as US$326 in early June and recently traded at about US$320. It’s a modest gain, but enough to bounce gold stocks upward. “Smaller companies live on a knife’s edge; they have less money; they’re closer to death’s door,” says Doug Pollitt, a mining analyst with Toronto-based Pollitt & Co. Ltd. “When the gold price turns around, it’s the smaller companies that have the most to gain.”
Explaining gold’s behavior is always tricky. One factor is that some investors view the yellow metal as a haven in uncertain times. Unlike fiat currencies like the Canadian dollar and British pound, gold is a hard asset with intrinsic value. This quality has made it attractive during previous crises. And facing a host of fears—the potential for more terrorist attacks against the US, rising tensions between the nuclear neighbors of India and Pakistan, and a plunging stock market—panicked investors may again be turning to gold. “The idea that gold is especially good when bad guys are especially bad has centuries of history behind it,” noted Don Coxe, chief investment strategist at Harris Investment Management in Chicago, in a recent report.
But Coxe favors another theory: that the US dollar is massively overvalued and destined for a huge correction. “Ultimately, only one factor will drive gold and gold stocks: the depth of the dollar’s decline,” he wrote. “Gold and gold shares make sense for people who worry about the overvalued greenback.” And then there’s hedging: gold firms are doing less of it, which should further buoy the price.
Analysts at Beacon Group Advisors Inc. in Toronto forecast rising gold prices over the long term, and their reasoning has a lot to do with the exploration slump. Exploration companies are a vital segment of the mining food chain: they find metal deposits that can be harvested to feed future demand. But owing to the low gold prices of recent years, nobody’s been looking for new deposits to replace ones that are steadily running out of ore. (According to the Metals Economics Group in Halifax, global gold exploration spending fell from US$3.3 billion in 1997 to just US$850 million last year.) “That’s like selling off a bit of your farm every year,” says Pollitt. “Eventually, you end up with no farm.” Beacon predicts that if today’s gold price holds steady, gold production in 2010 will be only 83% of the estimated 83.6 million ounces mined in 2001.
But others predict that the gold bugs are about to be squashed. Daniel McConvey, an analyst at Goldman Sachs & Co., recently advised his clients to take profits from their gold stocks and run. “We believe that gold will be more challenged to rise substantially,” he wrote them. That’s bad news: gold stocks are expensive to begin with, relative to the current gold price. Even those who do predict a rising gold price can’t say when; Pollitt, a true believer, notes that “if the gold price goes up in 10 years, a lot of these companies won’t be around to enjoy it.”
If you’re planning to invest in gold, many advisers suggest you stick to companies that have production and reserves. But if you insist on playing the exploration game, be prepared to live on the knife’s edge. Mitchell recently exercised 50,000 of his Orvana options, but says he’s holding out for Don Mario to enter production—and for a further increase in the gold price—before selling his shares. Here’s hoping his timing is better this time around. |
