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How To Price a Gold Stock

One of the most difficult things I have tried to do lately is explain how I value a mining stock. It's a mixture of voodoo and math that doesn't translate well. Some stocks explode as Durban Deep did today and others lie there in a comatose state. Since Novagold has been one of the more active and interesting of the small golds lately, I will share with you many of the factors I used in approaching the stock.

I didn't discover either Donlin Creek or NovaGold. I've never been to Donlin though I did do some mining near there in 1980. (Hint, don't ever try mining at the top of a mining boom. When everyone loves gold, get out and do something else or plan on spending a lot more money than you planned on everything).

And I wasn't the financial genius who first recommended Novagold as an investment. Jay Taylor first discovered the stock at C$.44 18 months ago only to watch in horror as the stock dropped to $.13 a share a year ago.

After Novagold announced a profit of C$.14 a share in March of last year, Lawrence Roulston recommended the stock at C$.35 a share.

I didn't even stumble across Novagold until August of 2001 with the stock at a lofty C$.80 a share. When I recommended the stock to friends, the typical response was, "I don't want to buy a stock that has gone up 500%, too much risk."

I wrote my first piece on the company when the stock hovered at about C$1.20 and another piece a month ago with the stock at C$1.80. I continue to be amazed at the volume of sheer skepticism which is just as strong now as when the stock was as $.13 a year ago. It's as if gold bugs can't stand the idea of a stock actually being undervalued. Get used to it, all the gold stocks are undervalued, Novagold only is more undervalued than most.

Novagold announced their new resource estimate for Donlin Creek a little over a week ago. Their 2001 program found significant gold in 41 out of 42 holes and doubled the resources. The market pretty much yawned.

Around the first of March, Novagold meets another important goal in their ongoing progress at Donlin. I thought I would try to define it so average investors would understand why it's so important. I remain convinced Novagold is just as good a buy at C$3 a share as when it was C$.13 a share and earning C$.14. Novagold isn't even valued anywhere near its potential.

This is going to sound a little stupid because it's so basic but the development of every mine goes though certain stages. And professionals considering investing in mining companies assign a certain value to resources at each stage, increasing gradually until the mine actually goes into production. Here's a rough estimate of typical values.

The sequence is:

1. Scoping study $10 per ounce (Around the 1st of March, 2002)

2. Pre-feasibility study $20 per ounce (October 2002 along with new resources based on 2002 drill program)

3. Feasibility study $30 per ounce. (Spring of 2003)

When a mine actually goes into production, values can range from $27 a resource ounce to as much as $138 for Goldcorp.(another very well run company) With gold at $275 the median for North American Gold producers was $74 an ounce.

For more discussion of feasibility studies, go to
www.minesite.aust.com/minesite/feasabil/objectiv/fea_obje.htm

In general, each of these studies addresses:

• Geology and resources
• Mining and ore reserves
• Processing
• Transportation
• Price expectations
• Infrastructure

And most importantly, the real decision from each stage is whether the project is attractive enough to continue on to the next stage.

So in about a month, Novagold announces the results of their scoping study. We can safely presume the market will assign a different value to NRI-TO after the study. But let's go into some of the factors of pricing a mining stock especially Novagold because there are so many aspects to consider.

In my view, probably the most important asset a company has is the quality of the management. Management is more important than any other area but the hardest to measure. Those considering investing in Bre-X or writing about the company should have focused first on the management. Without having been an investor but knowing how people work, I'll guarantee all the warning signs were there if someone had been looking for them.

I'm in a position I can call up the management of most mining companies and at least be heard. But I used to do the same thing when they didn't know me from the man in the moon. There are companies whose numbers looked good but who make it impossible to speak to management. I refuse to invest in companies where I can't talk to a human being and be heard. You not only learn about things they haven't gotten around to posting on their web site, it gives you an opportunity to give them the sniff test. If they fail the sniff test, hang up and don't invest. Scammers will always figure out a way of running a scam. You can't outsmart them, they make their living by taking money from people smarter than you or me.

I like the management of Novagold. I've talked at length to three out of four of the top guys. They are mining professionals, smart and dedicated. If they give you a number, you can pretty much take it to the bank. That said, if you want to consider investing in them or anyone else and it's a considerable amount, give the company a call, it's fun to feel you know the head guy when someone does a piece about them.

So I rate management higher than any other aspect and as far as mining companies go, NovaGold has as good a management as any I know. It's my opinion but it's an educated and experienced opinion.

Novagold is actually a handful of operating companies. Everyone knows about the Donlin Creek project because the numbers are so incredible but it's just part of their stable. Here's what they have:

1. They have an existing sand and gravel operation in Nome with 26,000,000 tons of gravel washed and sorted, ready to sell.An evaluation based on net present value assigns a value of $2.69 to their gravel operation all by itself.

2. They own 14,000 acres of land near Nome which they bought as part of the old Alaska Gold Company. The land is suitable for development as well as mining. This has a net present value of $2.15 per share.

3. They have 5 miners with leases on some of the 14,000 acres they own and an additional 15,000 acres near Nome they control. Last year Novagold only took in 250 ounces of gold as a royalty ($68,750 in revenue) but this is the area which could get real profitable real quick. Everyone thinks of them as strictly an exploration company but they aren't.

4. Above $325 to $350 an ounce gold, they will open a paleo-beach placer mine at Nome. When the Alaska Gold Company operated the mine, they aimed at a 25,000 - 30,000 ounce per year operation using simple and inexpensive gravity gold recovery. Novagold already has plans for scaling up the operation to something between 50,000 and 150,000 ounces per year. The deposit has already been permitted and requires little capital. Few investors realize the mining companies which gain the most from a rise in the price of gold the soonest, are placer mines. In the event of gold jumping to $350 between now and summer, the management of Novagold have already prepared a contingency plan. This "hidden mine" has escaped every other analyst writing about Novagold.

Novagold brings in money from their existing operations in Nome. Last year it was about C$4 million, in 2002 they believe it will be C$8 million. Based strictly on a Price/Earnings ratio, they have a trailing PE of about 24 and a leading PE of 12. And that's not even considering Donlin Creek.

Novagold is undervalued if you assign no value at all to their Donlin Creek and other deposits. I am using their numbers but I have no reason to disagree with them. If you ignore Donlin Creek and the other three over 1 million ounce deposits they own, the company has a net present value of at least C$4.84 and will have a PE of 12 for 2002.

So far, we have compared a mining company by looking at the sum of the parts and by looking at an existing PE. Now let's look at a comparison of some other mining companies.

No two mining companies are exactly alike in terms of progress on projects but these companies below are companies with good management and are roughly similar to Novagold.

Everything is fairly simple up to this point. I have showed that Novagold is underpriced based on assets, PE and in comparison to other similar companies. But what should stick out in the above table and what I have tried to make clear in my previous articles is the rich nature of Donlin Creek. In my view it is indeed another Carlin Trend and that's what an investor should be thinking. They have almost half an ounce of gold per share at $250 gold but look at what happens if and when gold goes up.

There is no conspiracy holding down the price of gold. I know there are some big names who support the conspiracy/manipulation mantra but it's nonsense and fairly easy to see in the two charts below.

In 1995, Robert Rubin became the Secretary of the Treasury under Clinton. Robert Rubin is the ultimate Wall Street insider and a former Harvard professor. He brought to Washington his theory of a strong US dollar policy. His strong dollar policies weren't done behind closed doors, they were out in the open for everyone to see. And if you look at a chart of the US dollar, you can almost pinpoint when he arrived in Washington.

chart courtesy of Kevin Klombies IMRA

Whenever we talk about the price of gold (POG) it's easy to forget we are actually talking about two different commodities. One, of course, is gold. But the other is the dollar. And since the value of an ounce of gold is an ounce of gold, and an ounce of gold is quoted in US dollars, when we quote the POG, what we are really doing is quoting the value of the dollar based on ounces of gold.

If you change that only a little bit and quote in currency units other than the dollar, it is obvious that the POG in all currencies other than the dollar has been climbing since September of 1999.

chart courtesy of Kevin Klombies IMRA

Since the basis of the conspiracy claim is that some mysterious CABAL is holding gold down and the price hasn't gone up since the conspiracy began in 1995, all we have to do is look at the chart.

And we see gold has been going up in every currency but the dollar since 1999 and it's actually the strong dollar policy of Robert Rubin which has caused the appearance of a weak POG. What has really happened is that the dollar has gone up rather than gold going down.

I hold a strong opinion that the price of gold will soon change. I believe gold bottomed in September of 1999. I have said so, and here it is for the record. Gold is in a bull market. The bottom is behind us. Also I believe there are two different scenarios either of which is possible.

One is to recognize how dangerous the strong dollar position of Robert Rubin has been to not only our economy but to the rest of the world. While Americans enjoyed rapid growth and low inflation, we exported our deflation to the rest of the world while they eventually shipped up to $450 billion dollars of their money a year to the US to finance our balance of payment deficit.

We only have to look at the stock market bubble of 1999 and 2000 to realize what a giant mistake the strong dollar policy has been. We created the biggest asset bubble in history and are only beginning to enjoy the pain as the chickens slowly come home to roost. The bankruptcy of Argentina is the direct result of our strong dollar policy since they tied their currency to ours. But they lacked the ability to continue printing dollars in a credit bubble which most Americans still deny.

That money must return home one day. It's the nature of the international system. When it does, the dollar will drop. And even President Bush has begun to recognize the damage done to our manufacturing sector. Our "leaders" in Washington are still in denial but the effects of the strong dollar have brought down Argentina, may well bring down the Japanese banking system and cause more bankruptcies in the US than in our entire history. let there be no question in your mind as to how I stand, the strong dollar policy was a mistake and will ultimately be blamed for the depression we are so swiftly approaching.

At a minimum, I expect the US dollar to begin falling within the next two months. There is a lot of "hot' money from both Japan and Europe chasing assets right now. The Japanese banking regulations decreasing government protection of bank accounts takes effect on March 31st which is also the last day the Europeans have to place their bets in the "legacy" currencies. Right now both the Europeans and Japanese are betting on the dollar and gold in about equal numbers so we have the bizarre experience of watching gold and the dollar get stronger daily.

One day soon the dollar will weaken. My guess is 30-40% which would result in the POG climbing 45-60% in dollar terms. So I believe $400 to $450 gold is quite possible. For all the nay sayers out there who are so quick to criticize any opinion of others, just look at what the price of copper did last week. In one day it climbed 5%. Gold and silver can easily do the same and I believe they will.

I could go back and redo the table comparing Novagold with the other four stocks but the key is that Novagold has so much more gold resources per share. If gold goes up and the resources of the other stocks increase at a similar rate to Novagold, NRI still gains the most because they have is 2-3 times the amount of gold resources per share of stock. So no matter how much gold goes up, NRI gains the most benefit.

If you accept the value of existing Novagold assets at about C$4.84 and wanted to figure out how much Donlin would increase in value to achieve the $10, $20 and $30 figures for scoping, pre-feasibility and feasibility study benchmarks, I have worked up the numbers with gold at $275. If you add C$4.02 to the C$4.84 figure, NRI should be worth C$8.86 with the release of the scoping study.

It would go up another C$3.94 to C$12.80 in October with the release of the pre-feasibility study and up to C$16.74 with the completion of the feasibility study.

My SWAG for Novagold with $450 gold is C$20 to C$50 and I suspect I might be quite conservative. You are dealing with a company whose management owns a lot of the stock. Novagold will go into production far faster under their current management than under any other situation. They all own stock and you may rest assured they have the interests of the shareholders at heart. If you profit, they profit.

And I also have a doomsday scenario for the price of gold. In my doomsday scenario, gold and silver will regain their historic use as the basis for the monetary system just as they did for most of the last 3,000 years.

JP Morgan/Chase has a derivatives book of about $30 trillion dollars. The GNP of America is about $9 trillion. Someone last week did a story, which we posted, about the Fed stepping in to save JPM because they are too big to fail.

Pardon me for being especially stupid but I fail to see how an economy of $9 trillion can possible bail out a single company which might have losses well into the trillions. The real question should be "Is JPM too big to save?" or "Is JPM too big not to fail?"

I know a variety of writers, some of whom I really respect, have bandied about a POG well into the four figures. That's my scenario, if and when the banks close here, (if it can happen in Argentina and Japan, you think it won't happen here?) the limit on the POG could be $2,000 or $5,000. It almost won't matter what mining stock you buy, all of them will be wildly profitable, remember there is about a 400-800% leverage. If gold doubles, your stock should be up 4-8 fold.

In that case, I would love Novagold even though all gold stocks will have a performance most of us only dream of. At $250 gold, NRI has about 10 million ounces which can be mined economically at Donlin, at $350 gold it goes up to maybe 16 million ounces and at $450 gold it goes up to 21 million ounces. You may rest assured the price of the stock will reflect the incredible resources behind each share.

I like all gold/silver shares at the present time but I love Novagold shares. They may have already gone up 2500% but they are still underpriced. The stock has wonderful liquidity so you could trade them if you wished or you can buy and hold. In any situation from $250 gold to $2,500 gold, Novagold will be both a leader and a winner.

Bob Moriarty
February 7, 2002

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