Stock Values

Today’s trade is not for the faint of heart. It is quite speculative and definitely a step away from my strategy of buying quality large cap stocks on weakness that I have outlined in a previous blog entry. Today I bought IAMGOLD Corp. (IAG), the world’s 10th largest gold mining company, at $7.84. I have bet on gold outperforming before when I bought Streettracks Gold Trust (GLD) on 12/30/2004 at $43.80. Now, almost 2.5 years later when gold has already risen well over 50% in dollar terms, it is difficult to count on it going up as quickly.

What would drive gold even higher is the lowering of interest rates by the Fed. “Lowering, but they should really raise it,” you say. That’s right they really should raise rates, because the government’s core CPI numbers are seriously understating the true rate of inflation. However, if you listen to Ben Bernanke, he said with a straight face over and over that inflation, as expressed by core CPI is overstated! With this philosophy in place, the core CPI hovering close to the Fed target and the easy credit real estate bubble in the bursting, chances are good that Bernanke will sacrifice the $ and push interest rates lower. When will this happen? He may do this as soon as at the next Federal Open Market Committee on May 9th! Buying gold would hedge against such a move by the Fed, but anticipation of such a move is already built into the price of gold.

So I turned my attention to Gold miners. Looking at the top three gold producers proved unproductive. Barrick Gold Corp (ABX), which reported its earnings last week, gained more than 10% over the next three days and before I had an opportunity to buy it. Newmont Mining Corp (NEM), a Colorado based company is having problems that will not be easy to overcome… and so I went down the list until I ran into IAMGOLD, a Canadian company that trades in Toronto under the symbol of IMG and in New York as IAG.

IAG’s stock price has been stagnant and the company is currently trading within 10% of an almost 18 month low. It has recently completed a merger which will enable it to produce over 1,000,000 oz of gold this year, which at the projected cost of $395 / oz and an average sales price of only $600 / oz (almost $100 below current spot price, allowing for sale of gold under hedging contract obligations assumed in the merger and negative market variations) will translate to earnings of $0.74 / share in the current year, so the company has a great opportunity to pleasantly surprise analysts, who are on average expecting only $0.44 / share profit this year.

Also, analyzing IAG’s most recent financial records, notice that IAMGOLD owns a significant amount of reserve bullion gold recorded on the balance sheet in compliance with GAAP at cost, in essence understating their current assets by close to $50,000,000. Taking this into account would improve their impressive current ratio by another 15%. Furthermore, IAMGOLD does not have hedge contracts, beyond those assumed in the acquisition. And certain of IAMGOLD’s mines are recorded and operated in Euros. These assets appear to be significantly undervalued on the books in $ terms, since the Euro gained much strength against the $ in recent years.

Institutions too, are starting to recognize the value that is IAG. Over the past 3 months they have added 5 times more shares than they sold, increasing institutional ownership of the stock by over 15% to almost 48% - that’s something like three times the average institutional ownership of stocks in the Gold and Silver Industry!

But are there risks to buying IAG. Of course and there are plenty of them. Here are some of them: Bernanke and the Fed could try to defend the $ against foreign currencies by significantly raising interest rates or Central banks could dump gold from their reserves, or the demand in major gold consuming countries US, India, China could drop, or an alchemist could finally succeed in making gold from a less expensive metal. (They did it with diamonds, so why not gold?) All of these would likely lead to a decline in gold prices. On the other hand, input costs, such as energy and transportation could raise significantly making production costs higher than was anticipated. Or the costs of doing business in certain countries with IAMGOLD owned mines could go up significantly through labor legislation or additional taxes. There are plenty of other risks as well and that is why I started this article by saying that this investment is not for the faint of heart, but if all goes as it most likely will, IAG stands a good chance of trading at double its current price in less than 18 months.