Gold has had a nice run up since late last week, giving us reason to take another look at gold equities. However, the Market Vectors Gold Miners ETF (NYSE: GDX), comprised primarily of major gold mining companies, declined 16.3% in 2011. GDX has been quite volatile and is currently hovering around the ~$50 mark. The Market Vectors Junior Gold Miner ETF (NYSE: GDXJ), which is the benchmark for the development-stage and junior gold mining companies, fared even worse last year. GDXJ finished the year down 38.1%, likely over investor concerns that development-stage companies would have difficulty securing funding due to a tight financing environment. Billionaires John Paulson and George Soros remain bullish on gold.
Many investors have been perplexed by the underperformance of gold stocks relative to gold. Likely explanations include concerns that gold prices may decline from current levels in future years and that costs may rise more quickly than revenues. On the back of strong financial performance in the industry, we remain bullish on select gold equities like NovaGold and AngloGold (NYSE: AU) (see Why John Paulson Loves AngloGold).
NovaGold (NYSE: NG) is a company we like with some potentially “world class” projects currently under development. Even though the company made significant headway on its three main projects— Donlin Creek, Galore Creek, and Ambler—shares of the stock declined 40.6% last year. We suspect issues surrounding funding were likely the cause since Galore Creek and Donlin Creek will both rack up capex budgets in the billions of dollars. Both Teck Resources (NYSE: TCK) and Barrick (NYSE: ABX) have publicly endorsed Galore Creek and Donlin Creek.
During 2011 NovaGold and its partner ABX completed a feasibility study for the Donlin Creek project in Alaska. This project hosts one of the largest undeveloped gold deposits in the world, with estimated reserves of 34 million ounces, and is expected to produce 1.1 million ounces of gold annually. We agree with many analysts that the Donlin venture has the potential to be a first-in-class asset but as with most mining developments, patience is required as production is still several years away. Environmental permitting alone will take 18-24 months.
Galore Creek, the joint venture between NovaGold and Teck Resources, is a copper-gold project in British Columbia with a feasibility study underway. When developed, Galore Creek will produce 325 million pounds of copper and over 200,000 ounces of gold annually. The Canadian federal government and British Columbia government have agreed to build a high-capacity transmission line in the northwest region, which will provide an adequate power supply. This is often a cause of delay in mining, so it is positive that the government is supportive and assisting to secure a power source. In the upcoming quarters, management plans to complete the Enhanced Plan, which is required for permitting and for a feasibility decision. Again, development of this asset will take some time; once the feasibility study is complete, we budget a few years for permitting and another few years for construction provided there are minimal delays and/or cost overruns. 2018 is probably the golden year for both Donlin Creek and Galore Creek in terms of starting production. NovaGold has intentions to sell its 50% stake in the Galore Creek project, which we see as another phase of the company’s restructuring plan.
Management has responded to lackluster stock performance by planning a strategic restructuring that will involve the spin-out of the Ambler project into a new public company called NovaCopper and the aforementioned sale of its stake in Galore Creek. Investors of NG should receive shares of NovaCopper on a 1:6 with NovaCopper listed on the Toronto Stock Exchange and American Stock Exchange in April (shareholder vote is this Wednesday). The Ambler asset in Alaska is polymetallic (gold, silver, zinc, copper, and lead) and initial valuation puts it around $400 million. Further drill results on the deposit should come out in the first quarter.
We believe that the restructuring efforts and feasibility study results will serve as catalysts for the stock. There has been speculation of NovaGold as a takeover candidate. And while we do not think that is a likely scenario, we do see a lot of potential in the Galore Creek and the Donlin Gold assets. Keep in mind though, that the final decision on when to develop these projects will be made alongside ABX and TCK, which adds an element of uncertainty. All in all, NovaGold has some great assets with enormous upside potential farther down the line. Naturally, valuation will change based on the outcome of the feasibility studies but with the stock trading around ~$7 and the NovaCopper asset set to spin-out next month, we think now is a good time to start building a position.
