For three days in October of every year, an eclectic assortment of mining executives, brokers, analysts, institutional investors, journalists and assorted gold bugs gather in the Denver Gold Forum. They come to hear company presentations, discuss opportunities, share ideas, or size-up the competition. Conversations you overhear range from heap-leaching methods to central bank monetary policies and from derivative valuations to third world political risk. You hope to leave having learned something useful--perhaps even profitable.

This is our second trip. We came to the Forum last year looking for answers to two questions: If the price of gold were to stay low for a long time, which one of these companies would survive--or even prosper? And conversely, which one of the same firms had the most to gain from a price recovery? Unlike some of the participants looking for "leverage", "upside potential", or forever expecting the end of the world, our interest in gold was (and is) simple. We are searching for Buffett-like absolute value, and an exceptional franchise, at a price we would buy the whole company. It is not as easy as it seems.

Mining is not really a good business. On an collective basis, if one were to compute the amount of cash generated on the cumulative amount of capital invested, and against the risks undertaken, the results would be ridiculous. It is a business fraught with risks. The capital requirements are intense. The development times are long. The environmental, logistical and myriad of other factors are daunting. The task of replacing depleted reserves leads to errors of all sorts. Business history is replete with stories of good money destroyed in the pursuit of a dream of gold--not to speak of the unsystematic risks (read 'frauds') that surface from time to time.

We are not contrarian for its own sake, but rather on account of fundamental and real inequities in the market that quite frequently misprices the value of underlying assets. Yet, since one is unable to forecast the future direction of prices--and particularly prices of assets that are influenced by external inputs, such as gold, it becomes imperative that we limit our investments in firms whose future is not at the mercy of the commodity itself. As an example, one can be fairly certain that Royal Dutch will be around no matter how low the price of oil or how long it stays low. An investment in Royal Dutch may not produce the total return that a junior oil exploration company might. Yet, on a risk-adjusted basis, the return is likely to be more certain and absolute.

Many learned observers, such as John Hathaway of Tocqueville Asset Management, have recently made considerably astute and powerful arguments in the case for gold. We agree and believe that notwithstanding the volatility in price that is likely to remain in the next 12-18 months, eventually, when the dust settles, the short positions reconciled and the dynamics of supply and demand come into equilibrium, the price of gold will be considerably higher than what it is today. No one can forecast the timing or the price level. But one can be fairly certain as to the economic inevitability of such event.

Thus, sometime between now and then, the shares of gold mining companies, will become the new darling of Wall Street. Our own search disregards this possibility entirely as it seeks to find the most golden of the gold miners, in a manner not any different than that of finding a great company in any other business.

In the automobile business, one can say that Company A produces better cars than Company B. Their ultimate product or service can be compared to that of their peers before other financial considerations are made. In the case of gold and precious metals, the ultimate product made by every competitor is, essentially, identical. No one can tell the difference between gold produced by Barrick Gold and Newmont Gold or a lone prospector with a pan on some Alaskan river. The technology of extracting gold from ore is well known. The methods similar. Differences lie in substance; and in the philosophy of the people who run these companies. The manner in which corporate managers have operated in a low price environment, speaks volumes for their understanding of their business, their respect for the shareholders' capital and their savvy in survival.

In recent times, a number of gold producers have been able to mask their inherently unprofitable operations, or create an appearance of remarkable results, by dealing in the derivatives markets, selling their future production and dabbling in all sorts of "hedging" and financial engineering. Much of this activity took place in the name of 'enhancing shareholder value'--a phrase that more frequently means enhancing the value of the managers' options. Indeed, one can keep warm by burning his furniture. Yet, a time will surely come when, having exhausted his furnishings, he will realize that his condition has not changed. Many of these companies are well known and popular with both institutional and private investors. But in the view of many discerning professionals, their actions are not only antithetical to the best interests of their shareholders but have also sustained the creation of a large short position in physical gold which hurts the entire industry and introduces exogenous uncertainty in an otherwise risky business. The greater the forward "hedging" means that a higher gold price is not only unlikely to contribute to their profits but also destroy the financial house of cards that such speculation can often entail.

These are the arguments that we consider vital in choosing an investment vehicle among gold producers:

• Very large and low cost reserves;
  
  
• Low cost of production (without financial engineering or accounting gimmickry);
  
  
• Ample margin for error, low commodity price or adverse conditions;
  
  
• Experience and track record in adding to the resource base;
  
  
• Management that is unconcerned with the next quarter's results but seeks to preserve and enhance the equity for the long-term;
  
  
• Technical savvy and a commitment to innovation;
  
  
• Concentration of resources;
  
  
• Wise management of the balance sheet, and
  
  
• Lastly, the ability to answer 'yes' to a Buffet-like question such as "If I owned the whole company, would I hire these same people to run it?"
  
  

Inasmuch as an event like the Denver Gold Forum provides ample opportunity to make qualitative judgments of a company's managers, we feel the need to distinguish between those managers whose aim is limited to personal gain, vanity or both, and those who are true custodians of their shareholders' capital. Notwithstanding the necessity for rigorous quantitative analysis, the "nose factor" has the last word.

Four companies have passed, for a second year in a row, our rigorous pencil and "nose" tests. We mention their names not by way of an investment recommendation but as a sign of recognition in outstanding value and with the full disclosure that we own their securities. All of these companies are superbly managed, resource-rich, impeccably well positioned for any market environment.

• Principal among our favorites is the largest North American producer, Newmont Mining Co (NYSE:NEM) a company best described with superlatives in both substance and form.
  
  
• Toronto-based Franco-Nevada (TO:FN) is the inimitable owner of royalties in gold, PGM metals, nickel and diamonds. With an operating profit margin better than that of Microsoft and an outstanding management team, Franco is a growth company first and a gold company second. We applaud its clean accounting, patience in building and/or acquiring value, no nonsense attitude and disregard for the noise from Wall Street.
  
  
• On account of the company's exposure to sovereign risk in Indonesia, the shares of Freeport McMoran Copper and Gold (NYSE:FCX) sell for less than half the price they should fetch even in a bear market for the metal. Freeport is the lowest cost copper producer in the world. Essentially it produces gold for free. Its only asset is the mammoth Grasberg Mine in Irian Jaya, Indonesia, and its management is legendary.
  
  
• Finally, considerable merit must be given to Stillwater Mining Co (NYSE:SWC), the only producer of platinum/palladium in our hemisphere. On account of temporary setbacks incurred in connection with the company's aggressive expansion in production, short-sighted investors have lost their understanding of the massive resource and value this company holds, thus giving us further opportunity to acquire its shares.
  
  

We leave Denver a bit wiser than we came but, more than ever, more certain of what is real and what is not. Whether metal prices go up or down (and they will), we are confident in our shareholdings, their value and their people. In the final analysis this is the best one can do in a business where all that glitters is, surely, not gold.

Anthony Deden
Sage Capital Zürich AG
deden@sagecapital.com

2 November 1999

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