Friday, March 16, 2007

Goldcorp Bubble

Gold Rush - Higher Cost, Better EPS Leverage

A company with higher production costs will experience more leverage in the growth of earnings at the beginning of a gold rush.

Gold Bubble - Gold Up, Leverage Falls

The leverage of earnings declines rapidly as the price of gold increases when bubble valuations of 25 times earnings remain constant.

Gold Trouble - Bubble In The Making

Increasing gold costs means that gold price must go up in an amount equal to the increasing costs, or, the level of bubble valuation will increase.

Gold Gone - End Game

Leverage of the growth of earnings is dependent on production costs. The leverage of the growth of earnings gave stellar returns at the beginning of the bull market, but decline rapidly. The leverage of earns can no longer keep up or justify paying bubble valuation prices for gold stocks. Production costs increase during the life cycle of a mine, further reducing profitability. Gold stocks that sell other metals that have dramatically increased in price have had highly leveraged earnings of those metals (eg. copper) hide the declining leverage and profitability of the gold sales.


Over-Valuation of Goldcorp

The fundamentals of the mature gold stocks as a business have so vastly changed, increasing gold price won't save them, and won't have the same effect on profitability as it did in the past. Where bullion underperformed relative to stock in the past, I see a reversal happening because of the changes in market conditions.

All face increasing cost for replacement acquisitions, reduced quality of replacement properties, reduction of leverage of earnings, and indeed, if gold doesn't go up enough to cover those replacement costs, leverage works negatively.

The other key points are:

The leverage of earnings of both copper and gold.
The price elasticity of gold bullion to gold stocks, ie, market cap.
The increasing cost of acquisitions.
The roll of the life of a mine - increasing rates of depletion.
The roll of lower quality gold properties.
The roll of depreciating mines.
The level of reserves to market cap.

Conclusions on Goldcorp:
Gold prices must increase $230/oz to maintain earnings for Goldcorp.
Assets are depleting at a much higher rate than earnings.
Goldcorp is trading at about 3 times its value.
I wouldn't buy Goldcorp at US$10.
I don't see growth potential at that price.


Under Valuation of Northern Orion

The value of what's expected to be sold at half of today's market prices is $17 billion, 22 times the diluted market cap, and using a value of market cap being 10 times bearish price estimates give a today value for Northern Orion of $7.40. Northern Orion is grossly undervalued. It is a strong buy to $7 based of property holdings alone.

Earnings per share can be expected to increase to about $2/share even if copper is US$2/lb. With a target P/E of 10, once production is in full swing, target price can be US$20/share. With a target P/E of 8, target price can be $16.00.

Bearish Price Target: $12.40 (by 2015)
The Middle Road: $18.90 (by 2012)
Today's Prices: $28.60 (by 2011)

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