Can Smaller Miners Become Big Winners In The Gold Rush?

By Stephen D. Simpson, CFA | April 29, 2011 AAA

Gold is still the hot trade. While it's not that hard to remember when gold was an afterthought, squeezed between a quick summary of bonds and commodities during financial programming, it is now a leading investment class. Whether an investor's interest in gold is fueled by fears of inflation, economic and political turbulence, technicals, or even just a "greater fool" theory, the reality is that it has been a winning trade.

By now any investor with even a passing interest in gold knows a little something about the myriad of choices for investment. People can choose to own actual bullion or numismatic gold, resource mutual funds, specialized ETFs like SPDR Gold Shares (NYSE:GLD), or mining stocks ... and those are just the most popular options. (For more, see What To Do About Gold Now.)

Tutorial: Commodity Investing 101

Given that mining companies are the only entry on the list that can actually grow from internal strategic decisions, they are worth a serious look. Here, we'll consider some of the smaller miners, which can offer substantially more bang for the buck than major miners like Barrick (NYSE:ABX) and Newmont Mining (NYSE:NEM).

A Quick View From Above
What is interesting about mining companies is that they don't necessarily track gold prices, and that is particularly true for smaller miners. For small miners, performance is often significantly influenced by the company's efforts to bring mines into operation and increase gold production. Investors should also note that many (if not most) analysts expect gold prices to peak in the next year or two and then decline - that does not preclude successful investments in small miners and those analysts could certainly be wrong, but it is a detail to consider all the same.

Maybe it is a sign of the maturation of the company, but IAMGOLD has been relatively active in selling out of its various minority mine stakes and using that cash to develop its own assets. While the company has resources on three continents, there is some cause for concern about operating in locations like Suriname and Mali.

IAG does seem to have good growth potential over the next five years, but the company's cash production costs are on the high side. The company is also the third-largest niobium producer and that rare earth kicker might be why the stock's valuation is just slightly on the rich side for a smaller miner. Still, it does not seem too bad relative to its growth prospects. (For more insight, see Rare Earths: Are They Worth The Hype?)

Eldorado Gold
Eldorado Gold is a junior miner that is not afraid to operate in some rather unusual places. Eldorado is the only Western miner with significant gold operations in China, and the company garners about 40% of its production from Turkey (an area that has only started getting attention in the last few years). On top of that, the company is looking to develop projects in Greece and Brazil, the latter of which is admittedly not an off-the-board gold producer.

Eldorado has surprisingly low cash production costs and very significant growth potential - particularly if those development projects work out. This company not a terribly cheap gold pick based on its current reserve base, but Eldorado should be able to grow its reserves beyond the nearly 19 million ounces in 2P (proved and probable) at the end of 2010, which would merit a higher valuation. (For more, see Why Gold Could Go Even Higher.)

Yamana Gold (NYSE:AUY)
Yamana has been aggressive with its expansion plans and now has six mines in Central and South America to show for it, along with low cash production costs and high expansion potential. Yamana has also been relatively clever with some of its transactions - striking a deal with Goldcorp (NYSE:GG) and Xstrata (OTC:XSRAF) on the Agua Rica mine that gives those two companies a large stake in exchange for cash to Yamana and access to cash flow from the gold production. Yamana is going to have to prove that it can bring forth its development projects on time and on budget, but the stock valuation is not too demanding. (For more, see South America: Ground Zero For Gold Mining.)

The Bottom Line
Investors should never forget that investments in junior miners carry even greater risks than the already risky idea of investing in commodity producers. Junior miners often depend on just a few operating assets and one accident or double-crossing foreign government can smash their plans and destroy the value of the investment. That said, junior miners often offer the best chance of real organic production growth and very high leverage to high metal prices. While gold ETFs may satisfy many investors' desire for diversification, risk-tolerant investors may want to try leveraging their exposure even further and taking a flyer on a junior miner. (For more, see Strike Gold With Junior Mining.)

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