Feb 11, 2010
Tom Winmill: A Checklist for Investing in Gold Miners
(Flickr:)
Investing in commodities is usually a hotly debated area among value investors. In theory, being able to obtain commodities at a deep discount is just what value investing is. But, there is a tendency for investors to circle around this corner of the market only when commodity prices really heat up. It is easy to accidentally invest into a bubble and watch your margin of safety disappear. Still, I believe it is insightful to study how great commodity investors work, and provides us with a glimpse of his approach:
Gold had a good year in 2009. Tom Winmill’s Midas Fund had an even better one.
The $125 million fund, which invests in companies that mine or process metals or other commodities, was up 83 percent last year. That return beat 95 percent of the fund’s peers, according to data compiled by Bloomberg.
Winmill, 50, says his training as a lawyer helps him sift through engineering reports on mining deposits, Bloomberg Markets reports in its March 2010 issue. “That’s much more important than putting on your hiking boots and walking around the mine,” he says.
Among the items high on Winmill’s checklist when picking stocks: a miner’s ability to start production on time and on budget and to preserve the value of its shares. “I like to see a mining company that pays a dividend, occasionally does a stock buyback — instead of constant stock issuance — and doesn’t make dilutive acquisitions in order to extend their empire,” Winmill says. Those three things, combined with a good project, are key, he says.
As of January, Winmill had the majority of the fund’s assets in stocks of gold-mining companies. Returns on miners’ shares tend to amplify the returns on gold because of the companies’ operating leverage, Winmill says. That gave the fund a boost from a bullish market as investors sought to protect the value of their holdings. “The devaluation of the dollar and the bursting of the bond bubble are going to hurt a lot of investors,” Winmill says. “And inflation is going to hurt a lot of savers.”
Some of the key takeaways here are that an investor should spend a lot of time getting acquainted with understanding the engineering reports issued by these miners, to properly gauge the situation. Note that he does not find actually visiting the mines to be useful. There is probably good reason for that, someone who is untrained at gauging physical mining operations may inaccurately perceive activity. Engineering reports are a way to more objectively determine the mine’s prospects.
After looking at gold through his four filters of U.S. fiscal policy, U.S. monetary policy, market supply and demand, and geopolitical events, Winmill analyzes individual gold miners, hoping to take advantage of the operating leverage they provide. I thought Winmill’s checklist for mining companies was worth noting:
1. The ability to start production on time and on budget
2. Pays a dividend
3. Pursues share buybacks
4. Does not pursue dilutive acquisitions
A company with all of these characteristics would be one that is run by a sound capital allocator. After the commodities bubble burst in 2008, Rio Tinto was one miner that was hit particularly hard. The company engaged in a ruinous acquisition plan, financed by mountains of debt. The company was like a homeowner who purchased homes that they could not afford, with the hope that its price would rise, and that they would be able to refinance their mortgages. Eventually, the music stopped playing and Rio Tinto scrambled to find ways to infuse its balance sheet with capital and pay down debt.
I can’t say I have a lot of knowledge of good managers of miners and other commodity companies, but I do know that many investors like , who runs Contango Oil and Gas (AMEX:). In the Bloomberg article, Winmill goes on to mention a few companies that he likes:
Among the miners that meet Winmill’s investment test is Northern Dynasty Minerals Ltd. (AMEX:) The Vancouver-based company is developing Alaska’s Pebble gold and copper project in partnership with Anglo American Plc. Shares of Northern Dynasty, which is 20 percent owned by Rio Tinto Group, rose 124 percent in 2009. This year, the stock rose 3 percent to trade at $8.52 on Feb. 10. “They’ve got experienced, well-capitalized partners who really know how to get the ore out of the ground,” Winmill says.
Midas also owns shares of Jaguar Mining Inc.(NYSE:) The Concord, New Hampshire-based company is bringing older gold mines in Brazil back into production. Winmill says Jaguar’s output might reach 600,000 ounces in about five years, up from 115,000 ounces in 2008. He says the company is likely to be acquired. Jaguar’s shares jumped 114 percent in 2009. This year, they fell 14 percent to trade at $9.60 on Feb. 10…
Midas’s holdings also include Silvercorp Metals Inc. and Fresnillo Plc. Shares of Vancouver-based Silvercorp, which has been buying high-grade mines in China, rose 210 percent last year. Stock of Mexico City-based Fresnillo, which operates silver mines in Mexico, was up 244 percent in 2009.
Be sure to read all of the article, it’s a great look at how one investor operates. Warren Buffett has invested in commodities in the past, specifically silver, so it is worth taking some time to study. It’s always good to expand your circle of competence and a good value investor should be willing to travel through asset classes in search of value.