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Bonanza Discoveries That Will Drive Gold Stocks

SOURCE:[The Gold Report] - New deposits and economic triggers will drive gold stocks, says Eric Coffin, the editor of HRA Journal. In this exclusive interview with The Gold Report, Coffin identifies the management characteristics of gold juniors that make money for investors. A successful gold explorer in his own right, Coffin names his picks from the Yukon to the Caribbean.

The Gold Report: Eric, why is there a bear market for metal mining companies in a season of bulls?

Eric Coffin: Post-recession, there was a good bounce for commodity stocks. Two problems have slowed things down during the last year. One was fear of the fiscal cliff as the politicians in Washington argued about raising the debt ceiling. Banks were blowing up in Europe. Most important, weakening numbers out of China scared off a lot of investors, particularly from the base metals. There are simply a lot of people concerned about the economy in general, and, specifically, the growth economies where metals are keys to industrial development.

On the gold and silver side, the real issue is that gold is over $1,700/ounce (oz) and silver is now over $30/oz. It sounds as if I'm being ironic, but I'm not. At the start of this major cycle, gold prices were $300/oz. It was not the price-earnings (P/E) ratio that was determining the value of a lot of mining companies, it was the P/E ratio plus a very large amount added for in-the-ground resources. Goldbugs at the start of this cycle expected gold and silver prices to go up 500%. They were as interested, if not more interested, in the leverage, the "ounces in the ground per share" that gold stocks represented.

I'm not going to assume that gold is going to $10,000/oz. I'd be really happy if it does, but I'm not expecting it. What we are seeing now is that the P/Es for the gold firms are returning to the market average. In the past, gold companies could trade at 80–90 P/E. The earnings part didn't matter very much. It was all about the amount of gold resources on hand. Now investors are taking a harder look at how much money these firms are actually making. We can't just assume that gold is going up another 400–500%. So the P/Es have normalized.

Another concern is profit margins. Costs have gone up very rapidly in the mining business. For a long time that was because there was a skills shortage. Part of the reason why we expected this to be a long secular bull market was because we knew how short the industry was on all kinds of skills, material and equipment. The mining sector was not going to turn around and suddenly start producing twice as much copper, zinc or whatever at the same cost. As the price of metals rises, so does the price of a geologist, the price of an engineer, the price of a ball mill.

The situation will improve over time as more professionals are trained and the production capacity of industry suppliers is increased, but this takes time. The final piece of the cost equation for many metals is grade. As the "low hanging fruit" is picked and the industry moves to tougher terrain with less infrastructure and deposits with lower average grade, the cost of production rises. While I'm not a big believer in things like "peak copper" (at least not any time soon), supply is very much a function of price. If the world wants ever increasing amounts of metals it will have to pay up and pay the mining industry to supply them. The days of cheap metals, in most cases, are over.

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