All That Glitters Isn't Gold (RIO, BVN, PCU)

By Dean Lundell | March 22, 2007 AAA

It may be cliché, but it's true more often than not.

When it comes to gold stocks, there's more a than few that turn out to be less than gems.

The valuations of most gold stocks are essentially tied to the value of gold as a commodity.

And like any commodity, there is a time to buy them and a time to sell them, a time to hold them and a time to fold them.

Caveat emptor.

Strong as Iron
Companhia Vale do Rio Doce (NYSE: RIO) is a huge Brazilian mining operation with a market cap of almost $84 billion. They are the world's leading exporter of iron ore and produce substantial amounts of other base metals.

During the past three years, RIO has spent $8.8 billion on expansion, $21 billion on acquisitions and has announced plans to spend another $6.3 billion in 2007. While 63% of their revenue comes from iron ore, their stated goal is to become one of the world's largest diversified mining companies.

"Diversified" is a key word here, as that carries some additional risk with it. The ability to keep one's edge in your primary market is not necessarily transferable to others, such as nickel. By any profit or growth measure you can mention, RIO has done an incredible job, driven by the world wide economic expansion, particularly in China, where the company has a long-term contract.

Has all the good news been priced into the stock? It is hard to say, but keep in mind that RIO is currently trading at about a reasonable discount compared to its peer group.

A Safe Haven?
Buying Compania de Minas Buenaventura (NYSE: BVN) would be a pure play on the price of gold. Most gold miners do not earn their cost of capital but BVN is one exception to the rule. BVN is an exception because their expertise lies in finding high producing, low cost deposits.

The problem is that those mines happen to be in Peru. Other than the ongoing political turmoil, the prospect of royalty tax hikes are a very real threat to the level of BVN's profitability. BVN has unhedged about 25% of its portfolio, which could help the company if gold rises to a widely anticipated price of $675 an ounce.

A simple fact is, many considered gold a safe haven in times of political uncertainty. In addition to that, gold is also a safe haven or a hedge if you will, on a depreciating U.S. dollar. Should the U.S. dollar rally from current levels, it could have a negative impact on the price of gold and by proxy the price of BVN's shares.

A Penny for Your Thoughts
Southern Copper Corp (NYSE: PCU) has been enormously successful over the past three years. Soaring copper prices along with low-cost, high quality assets have provided PCU with staggering returns, many into the three digits. The major cause for concern is that those low-cost, high producing assets are in Peru and Mexico. Any royalty or tax hikes could hurt PCU dearly.

Should the global economy have a slow down, the U.S. housing market in particular, the price of copper could hit the skids. The operative words here are "should" and "could." Here is the cold, hard fact -- Southern Copper's shares are currently trading at a 45% premium to its peer group.

Pound for Pound
Just what are the "guesstimates" on the prices of these metals over the next year or two? You might see gold at $675 / oz, nickel in the high $13s vs. the current high $10s and copper to stagnate or perhaps even decline a small amount. And iron ore? Who cares, many emerging market juggernauts (like China and India) will buy everything they can get their hands on.

Caveat Emptor
Investment (long or short) in any of these shares is very risky business from any number of criteria. Changes in the global economy will yield almost spontaneous upside benefits or downside detriments. Investors should have an exit plan in place, win lose or draw.

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