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when enough is NOT enough

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    all gold bugs and others should read this

    By Thom Calandra
    Thursday, June 13, 2002

    Here's the question of the year: When the investing public,
    already headed for the exits, runs screaming from the U.S.
    stock market, how will gold mining stocks, and gold, benefit?

    Gold mining stocks, the best performing stock market group
    this year, have a life of their own. Since September, the
    mining equities actually have risen ahead of the spot gold

    Gold mining stocks, thanks to the weak stock market,
    nuclear war threats, and reduced forward-selling by miners,
    are juiced well beyond the pricing models of professional
    analysts. The Wall Street and Toronto mining analysts
    almost all use operating cash flows, profit margins, and the
    level of proven bullion reserves a company has in the
    ground as their touchstones for value.

    "Should a gold stock trade at 10 times earnings, 50 times
    earnings, 60 times earnings? Nobody knows the answer
    to that," says Victor Flores, senior mining analyst at HSBC
    in Toronto and New York. Indeed, gold mining stocks in
    some cases -- Gold Fields Ltd., Barrick Gold -- are selling
    for hundreds of times their profit for the past four quarters.

    A big chunk of the soaring prices of gold mining stocks is
    tied to what the grizzled bullion veterans call "the option
    premium." Investors during gold rallies anticipate a far
    higher price for the gold a miner sells and thus are willing
    to pay more for a gold stock than any financial planner
    can counsel.

    Thus, companies that mine rich resources at low cash
    costs, like Canadian producer Goldcorp, are expected to
    trade at extremely high multiples to earnings and cash flow.

    Goldcorp, its shares trading at 17 or so times cash flow,
    enjoys easy pickings from one of the world's richest gold
    deposits, the Red Lake Mine in northwestern Ontario.
    Production costs for pulling one ounce from the ground are
    among the world's lowest at $120 an ounce. That's a lot of
    profit margin if gold's price adds to its $320-an-ounce price
    in the next six months . . . or six days.

    Another golden rule for gold-company investors is pretty
    simple. The more a miner has in the ground, the fatter the
    premium gets. "Big mining companies are concerned with
    the size of ore bodies, ones that give them a long marketing
    cycle so they will hit high points in the (gold price)," explains
    hedge fund manager Rick Sacks of Phoenix Advisory Co.
    in Chicago. Sacks is a big believer in Crystallex
    International (KRY), which is awaiting a Venezuela ruling
    on Las Cristinas, a gold project with 8 million or more
    ounces of the precious metal in the ground.

    For those on Wall Street and Main Street who are wary of
    gold companies, and there are many who won't touch the
    stuff, the miners' soaring stock prices are even more
    reason to snub the equities. Rafe Resendes at research
    firm Applied Finance Group Ltd. in Chicago computes
    three-year cash flow margins for many companies, then
    determines the sales growth those companies will need
    to justify their stock prices.

    Newmont Mining, world's largest miner, has a three-year
    median sales growth of 6.5 percent and a three-year
    median cash-flow (EBITDA) margin of almost 34 percent.
    Newmont's sales will need to rise 35 percent a year to
    justify the current stock price, Resendes reckons.

    Tiny Richmont Mines (RIC) has the easiest road to travel,
    by these computations. With three-year median sales
    growth down 6 percent and a three-year median profit
    margin of 28 percent, Richmont need only boost sales by
    14.8 percent to satisfy this pricing model.

    "Obviously, should margins go up, the required sales will
    go down," says Resendes, who uses the model as a
    starting point, sizing up whether a stock is basically cheap,
    expensive, or somewhere in between . "These (gold)
    companies looked reasonably priced at half their current
    levels, but very expensive here in terms of what they must
    deliver," he says.

    But -- back to the safe-haven question of the year: What will
    happen to gold stocks when investors, drained by 2 1/2
    years of Nasdaq and blue-chip losses, throw in their
    red-ink stained towels? And they will, rest assured of that.

    "The Elliott Wavers are predicting the market will soon
    drop like an elevator with its wire cut, down to [post] 9-11
    levels and possibly below," David Ward, an investor from
    the U.K, sums up for me. "If true, that will scare the investing
    public witless. What will happen to the gold price then?
    And what price gold as the market recovers?"

    Ward notices that "over the last couple of days, as the Dow
    has toyed with 9,500, the Nasdaq Composite with 1,500, and
    the S&P 500 Index with 1,000, there seems to be a growing
    correlation between the price of certain high-beta gold
    stocks, like Durban Deep, and the stock market movement.
    Could market jitters be driving the price of gold stocks more
    and more, rather than the price of gold?"

    If you're comfortable with gold and gold equities, as I am,
    you can add that to the option premium of a gold-mining
    stock, sit back and enjoy the fireworks.
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