Buying Gold: Two Small Cap Gold Producers to Buy
Inflation is climbing and geopolitical tensions are high. The consistent hedge over the millennia has been gold. This is complicated, however, by rising interest rates, which increases the cost of opportunity for holding a substance that is largely unproductive. We can see this tension in the big spike to well over US$2,000 an ounce earlier this year, caused by the commencement of the invasion of Ukraine.
Which Two Gold Producers do we recommend?
Evolution Mining (ASX:EVN)
ASX Small Cap Gold Miner
Market Cap: 6.20bn
Net Debt: $449m
Why this is a Quality Stock
Some miners have the Midas touch and Evolution founder and CEO Jake Klein, previously a banker, is among the best in the world at buying and selling gold mines.
The miner now operates assets at Lake Cowal (NSW), Mt Rawdon & Red Lake (Canada), Mungari (WA) and Ernest Henry (Queensland).
These are world class assets. Ernest Henry for instance is an underground mining operation with a capacity of 6m tonnes/year. It has a conventional crushing, grinding and flotation plant (capacity up to 8.5m tonnes/year) which produces a copper gold concentrate. The mine life is over 9 years, with 4-5 year mine life extensions a strong possibility.
Radar Rating: A quality stock for the gold bugs. The company is one of the lowest cost producers on the planet, has very little sovereign risk and is growing production.
Northern Star Resources (ASX:NST)
ASX Small Cap Gold Miner
Market Cap: 9.27bn
Net Debt: $95m
Why this is a Quality Stock
We first covered the gold miner exactly a decade ago, when it was valued at $300m and headed by Bill Beament. He was animated, talking up the prospects of his flagship and only mine, Paulsens, having just purchased it for $40m from Intrepid Mines.
Beament has now left Northern Star, but not before it has emerged as one of Australia's largest gold producers. The stock has been under selling pressure, but still has a market cap well over $9bn.
This week the NST announced the sale of Paulsens and one other mine for $44.5m. This company knows how to make money!
What’s left is substantial. NST has three production centres: two in WA, Kalgoorlie and Yandal, and one in Alaska, Pogo and is on track to produce 1.55-1.65m ounces this year alone.
Production by the group is projected to grow 25% to 2 million ounces a year over the next three years. Moreover, growth is embedded in its asset base, which reduces risk considerably. There is no need for acquisitions or greenfields exploration. In fact, we are forecasting NST grows production higher than 2m due to its Kalgoorlie super pit asset
Despite cost pressures, dividends are forecast to climb 30% in the next 12 months from 23 cents this year to 30 cents in FY23. How about that for quality.A discounted cash flow valuation on NST can easily exceed $11 with conservative assumptions and $14 with an increasing gold price.
Radar Rating: Gold production growth forecast to lift dividend by 30% in next 12 months. Very strong balance sheet and cash flow generation the key to quality.
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Gold Analysis: Why gold has been a steady player in tumultuous times
This year the gold price has fluctuated over the last couple months between US$1,800 an ounce and briefly well over US$2,000 as the market turmoil has spilled over into commodity markets. But there has yet to be a sustained panic flight to the yellow metal.
If about nine months ago we had laid out the current set of facts, US inflation 8.6%, war in Ukraine, imminent global food shortages, oil prices at US$110 and counting, and strategic tensions all over, a casual observer might have expected a higher gold price, but this has not yet appeared.
In contrast, alternative inflation hedges like crypto currencies and it’s flagbearer Bitcoin have performed poorly against any yardstick.
It is worth remembering that the gold price remained relatively unmoved in the early part of the financial crisis in 2007-2008, and only moved substantially higher as the stock market recovered.
We remain of the view that holding gold miners is a reasonable way to hedge against all sorts of unknown unknowns.
Interestingly the major spike that did move the current gold price was in the moments when the television cameras were showing Russian tanks shelling a Ukrainian nuclear power station, and happily those images did not last long.
The relationship between gold and inflation is somewhat distorted by the 1970s and the fact that then President Nixon took the USA off the gold standard in 1971 at US$35/oz, and the gold price peaked in 1980 at US$800 per ounce it then fell for two decades until the late 90s and early zeros, when it started its climb from US$250 to reach close current levels in 2012/13.
The point is that gold can move in mysterious ways, but the fact is that it has been the most stable asset in purchasing power against other assets. Moreover, this has remained the case for millennia, underscoring its use as a store of value. Gold miners provide you with leverage. The producers that achieve consistency are few but are worth holding in any portfolio.
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