GORO : Why I Am Avoiding Gold Resource Corp.
1: About Gold Resource Corp.
Gold Resource Corp. has market capitalization of around $400 million. The company owns properties in the Oaxaca region in Mexico, where it operates its high grade/low cost gold and silver mine--El Aguila. It is highly profitable and committed to returning capital to shareholders through its monthly dividend, which comes out to a 5% annual yield.
A major problem with Gold Resource Corp. as a long-term investment is that the company is mining the high-grade areas of El Aguila first and using a significant portion of the profits to pay dividends; however based upon current resource estimates the company can only keep this up for a few years. Afterwards it has to either mine lower grade areas or hope that it finds additional higher-grade areas to mine in order to maintain its current margins and level of profitability.
With this in mind, one has to question Gold Resource Corp.'s rationale in paying such a high dividend: it has just one operating property that will be unable to sustain the company's dividend should it be forced to mine lower grade ore. El Aguila already saw a setback earlier this year, which along with lower gold and silver prices, forced the company to slash its dividend in half.
Ultimately, given Gold Resource Corp.'s minimal pipeline of additional mines, it is difficult to justify an investment in the shares for the long term. That being the case I also think that shorting the company's shares is far too risky a proposition. The prices of gold and silver have languished for a long time and are due for a rebound, which will in turn drive funds into gold and silver mining shares. Furthermore, while the company does not have a well-defined pipeline of mine production, it has enormous exploration potential.
2: Resources and Production
Gold Resource Corp.'s resources are all located at El Aguila, with its exploration properties showing signs of containing resources that have not yet been quantified.
The company gives three estimates for its total resources depending upon its "cutoff grade," as the chart below illustrates.
(click to enlarge)
What this means is that the company decides a boundary for the least economical grade that it is willing to mine: the higher this cutoff point then the less ore it has to mine and the lower its resource estimates, but the more profitable it is for the company to operate. Using the above figures, the table below provides the company's resource estimates for 1, 7, and 9 grams of gold equivalents as the cutoff grade.
Cutoff Grade
(grams per ton) Gold (ounces) Silver (millions of ounces)
1... 308,000... 30
7... 270,000... 26
9... 231,000... 22
While these estimates are not very high given the company's market capitalization, the fact that El Aguila has such high-grade resources, and given how easily Gold Resource Corp. can extract them, the company has been able to grow its production rapidly over the last few years, and it anticipates growing this production in the immediate future.
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Based on these production estimates and the company's resource estimates it is impossible to see how this production can continue more than 4 or 5 years into the future. If this were to occur the company would have to either find more high-grade resources or begin to mine lower grade ore, which will cut into the company's high margins.
Despite this concern the company should have relatively high cash flow as El Aguila maintains this high level of production, as the mine has relatively low costs. If the company has an estimated "all-in" cost of roughly $16/silver-equivalent ounce (given that the gold/silver ratio is about 65:1, and the company's gold/silver production is about 1: 100 I will assume that El Aguila is a silver mine), and produces about 14 million silver equivalent ounces, the following table estimates the company's cash flow in 2014.
Silver Price; Gold Resource Corp.'s estimated Cash Flow
$15/ounce; -$14 million
$20/ounce; $56 million
$25/ounce; $126 million
$30/ounce; $196 million
$40/ounce; $336 million
$50/ounce; $476 million
$100/ounce; $1,176 billion
Clearly the company offers substantial leverage to the silver price assuming that the gold/silver ratio remains relatively constant. Given that the gold/silver ratio is historically low, however, the company's cash flow may not be as strong at the given silver prices because this fact anticipates that the price of silver will outpace the price of gold, and the lower gold price relative to silver will dampen these numbers.
Further, while it appears that the company is undervalued as it trades at just 7.1 times its estimated cash flow at $20/ounce silver, keep in mind that these high production figures will be short lived, and a lower than average share price to cash flow figure is justified.
3: Gold Resource's Properties
Gold Resource Corp.'s properties are located in the Oaxaca mining region in Mexico pictured below.
(click to enlarge)
Historically this has been a very lucrative place to mine. Gold Resource Corp. itself has found a high-grade gold and silver deposit at its El Aguila property here, and there are other producing mines such as Fortuna Silver's and Continuum Resources' San Jose project.
In Addition to El Aguila the company has several exploration properties in the region: most notably its El Rey property and its Las Margaritas property.
El Rey
El Ray was mined briefly in the past and Gold Resource Corp. believes that there could be a potential mine here based upon some mineral samples it has taken. A couple of notable drill results include:
9.0 meters of 19.37 grams per ton of gold, 75 grams per ton of silver
7.8 meters of 20.34 grams per ton of gold, 78 grams per ton of silver
While this is not enough information to determine whether there is a mine at El Rey these are very high grades, especially for gold, and as a result the company is exploring the possibility that El Rey contains an economical mine.
Las Magaritas
Las Magaritas potentially contains a very high-grade silver mine. Gold Resources claims that there are historical records from 1905 of the property containing ore with up to 18,000 ounces of silver per ton, and more frequent occurrences of 4,000-5,000 ounces of silver per ton. These numbers are uncanny. The company has taken surface samples and has found more believable occurrences of 1,200 grams of silver per ton, although even this is significantly higher than any other producing mine in Mexico (The highest-grade silver mine in Mexico is La Platosa, which is 800-900 grams of silver per ton.). These numbers seem almost too good to be true, and given that there have been no geological surveys I would take these preliminary numbers with a grain of salt. Nevertheless if the company verifies these figures and determine that there is a high-grade silver mine here, then its share price will rise meaningfully.
Altra Gracia
Altra Gracia is a pre-exploration stage property on Oaxaca. While there has been some mining here in the 1970s Gold Resource Corp. has not done any exploration.
4: Risks
A: Gold Resource Corp.'s Future
As I have previously mentioned Gold Resource Corp. has a very limited pipeline of future production. For one, the company only has quantified resources at one property. The company's other properties all have potential, but there is no evidence acceptable to the mining community that there are enough resources at these properties to mine them profitably.
Furthermore, El Aguila itself has a very limited amount of resources. As I suggested above the mine can only operate for a few years before the company has to either find more resources or begin mining lower grade ore. The company can certainly find more resources, but there is no certainty of this happening. If it mines lower grade ore then its margins and profits will drop.
B: The Price of Gold
The price of gold has fallen precipitously recently, and the company's future cash flow is highly leveraged to the price of gold. So long as the downtrend illustrated below remains intact, there is a reasonable possibility that the gold price will continue to fall in the short term.
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However, this risk is mitigated by the fact that the cost of production for many of the world's gold producers is below the current price. Hebba Investments recently published a series of articles on Seeking Alpha on the cost of production for the world's largest gold miners. Here are its conclusions for some companies:
Miner Production Cost
Barrick Gold (ABX) $1,200
Newmont Mining (NEM) $1,300
Goldcorp (GG) $1,200
Yamana Gold (AUY) $1,300
Kinross Gold (KGC) $1,370
Agnico-Eagle (AEM) $1,400
*Data taken from Hebba Investments' article on Kinross Gold
Since it is unlikely that the gold price will be sustained below the cost of production, it is unlikely that its price will drop and remain below $1,200 for very long.
The Price of Silver
The price of silver, like the price of gold, has performed terribly over the past two years, having declined from $48/ounce to roughly $20/ounce. While there is significant technical support at the current price the downtrend that began in May 2011 is still intact.
(click to enlarge)
Most silver producers cannot turn a profit at the current price, and this is a reason that the silver price has likely reached or is near a bottom. Still the downtrend in the price of silver is intact, and Gold Resource Corp.'s profits will be correlated to the price of silver.
Conclusion
Gold Resource Corp. is not a good long-term investment because it does not have any solid plans for the future that do not involve luck: it has to find significant high-grade resources in order to maintain its current level of productivity and profitability. This certainly could happen, especially given that the company will have the cash flow to expand its El Aguila property over the next couple of years. But there is no certainty that this will happen, and ultimately there is a real risk of the company running out of resources. |
