Gold Fever is Spreading

March 23, 2009

Dear Outstanding Investments Reader:

I’m heading out on the road this week, so your update is a couple of days early. Meanwhile, keep an eye on your email in-box. Later this week you should receive the alert for your next OI monthly issue. The new investment recommendation involves high-end oilfield technology. This technology is absolutely critical for future offshore oil and natural gas production around the world. Really, if this technology is not deployed on a wide scale, you can kiss the Oil Age good-bye a heck of a lot sooner than anybody thinks. This sector of the oil industry is destined to boom. I believe there are great gains to be made from the key players in the field. Like I said, watch your email.

Gold Fever is Spreading

From the mining patch, we have AngloGold Ashanti (AU: NYSE) in the OI portfolio. I hope you picked up some shares over the past month or so. Because last week we learned that hedge-fund manager Paul Paulson paid $1.28 billion to buy a major stake in this great South African gold miner.

Apparently, Mr. Paulson (no relation to former Treasury secretary Hank Paulson) sees a solid-gold opportunity. And Paulson, you may know, has pretty good eyesight. He’s the hedge-fund manager who made $10 billion in 2007 and 2008 betting that the subprime mortgage market would implode.

Mr. Paulson made his deal just one day before Fed Chairman Ben Bernanke announced that the U.S. Federal Reserve would buy up to $1.2 trillion of U.S. Treasury debt. Mere luck? Pure coincidence? Makes you wonder. Because when the Fed released that news, the dollar promptly tanked and the price of gold quickly spiked upwards by near 7%. Many gold mining stocks saw significant gains within minutes.

Mr. Paulson buying into AngloGold Ashanti is, in essence, his $1.2 billion bet that the U.S. government is pursuing a long-term policy to debase the dollar. Dollar debasement will doubtless trigger inflation. Over time, this will cause a flight from paper currencies to gold. Gold miners should benefit.

I’ve already predicted gold at $3,000 within 30 months. I’ve heard other gold analysts forecasting gold at $4,500 within three years. So there’s a lot of room on the up-side. Buy gold. And don’t neglect the likes of excellent mining firms such as Goldcorp (GG: NYSE), Kinross Gold Corp. (KGC: NYSE) or Agnico-Eagle Mines (AEM: NYSE). They have great gold output profiles, as well as good cash flow. Also keep an eye on Yamana Gold (AUY: NYSE), recovering from a share-price drop after copper prices plunged last year. And for exposure to the rising silver market, look at Silver Standard Resources (SSRI: NASDAQ).

While I’m on the subject, Hecla Mines (HL: NYSE) has a great resource base of silver and gold. And Hecla has talented people onboard who know how to dig ore. But the company is suffering from too much debt in an era of frozen credit markets. Hecla go hit pretty bad late last year when prices tumbled for basic metals like lead and zinc. Hecla will recover, eventually. But it may be a slow ride out of the woods.

NovaGold (NG: AMEX) has its own cash flow problems. Like, its cash flow is not flowing. NovaGold is more of a “mine developer” than an up-and-running miner. Its one gold-processing operation, at Rock Creek, near Nome, Alaska, just did not get up to speed last year. The failure at Rock Creek came as a surprise to everyone, including NovaGold management. Nobody saw this one coming, including the insiders. Rock Creek was supposed to be yielding gold by the end of 2008, to fund the rest of NovaGold’s development. That didn’t happen.

So NovaGold hit the cash-wall in late 2008, and even now has financing problems. Yes, they’ve worked out a solution. But it’s a solution to the detriment and dilution of previous shareholders. Thus the stock is down. But at the same time, a lot of savvy investors own a piece of NovaGold. (Marc Faber, for example.) They anticipate – eventually -- some sort of action with the immense gold deposits that NovaGold controls at Donlin Creek, Alaska and Galore Creek, British Columbia. But for now, NovaGold is only for the patient stock-buyer.

Meltdown at Denison Mines

Speaking of the banking and credit crisis, it has just claimed another victim. This time it’s long-term OI holding, Toronto-based Denison Mines (DML: TSX). In the past six months, Denison shares generally suffered due to the slow market for uranium. Uranium was selling at $42.50 a pound last week, after trading as high as $136 a pound in 2007. As a long-term investor I could live with that. Denison stock was down, but poised for a recovery when the price of uranium rebounds.

Last week, Denison shares dropped 20% after the uranium miner suspended some operations and announced that it may have to sell assets to keep from violating a debt covenant. What happened? Well, Denison has a $125 million line of credit, of which it has drawn down about $100 million. When you’re operating with that much debt, you had better believe that the bankers are crawling all over you. Whether it’s business or personal, now is not the time to be in debt or to have to rely on the kindness of bankers.

So in this unfriendly credit environment, last week Denison announced its 2008 results. Revenues were up significantly in 2008, to over $123 million, from $76 million in 2007. That’s good, right? But earnings went from 25-cents per share profit in 2007 to a 47-cent per share loss in 2008. That’s bad. This included a good-will impairment charge of over $36 million in the 4th quarter – just announced last Thursday. (Thanks a lot, guys.)

On the face of things, 2008 should have been a good year. Uranium output was up, and the company is also producing valuable vanadium ore as well. Overall sales were way up. The resources base of uranium and vanadium ores grew. Reserves stayed solid. Safety improved. Regulatory compliance was good. But the debt overhang made it difficult to run the operations. Cash flow went to service debt and juggle loan obligations. In that environment, the big, bad wolf eventually shows up at the door.

At the quarterly conference call last week, Denison CEO Peter Farmer said the company was in danger of violating a debt covenant tied to its profitability. Thus Denison is reviewing “strategic opportunities” to keep that from happening. In other words, it’s not an issue with the ore, the mining, or the general operations of the company. It’s not even an issue of selling uranium into the current market. It’s all about keeping the company looking good on paper for the bankers.

Then again, if you don’t want the bankers to run your life you shouldn’t borrow their money. So now, deeply indebted, Denison has limited options. These include, “entering into off-take contracts with utility companies... asset sales, purchases and joint ventures, investments by private equity investors and potential corporate transactions with other uranium producers.” Another option to satisfy the bankers is the resignation of CEO Farmer, which was announced on Monday, March 23. Mr. Farmer has been with Denison since 1985, and generally has done a good job over the years. If only he had not borrowed all that money, though. Him and a lot of other people and firms and governments.

For now, Denison will temporarily suspend production at two high-cost mines (Sunday and Rim Mines) in the western United States. In May, Denison will shut its mill at White Mesa, Utah, after it processes 500,000 pounds of uranium the company is under contract to produce in 2009. The mill should restart next year. And the company will do whatever else is necessary to spruce up the balance sheet to please the bankers. This is the price of being heavily indebted in a time of contracting credit markets.

I have to move Denison to the “hold” category in the OI portfolio. I don’t think that Denison is going to go bankrupt. And I think that Denison’s asset base of uranium properties is VERY attractive. So I think that Denison will still be around as a going concern. But it’s going to be a long, hard slog to get the stock price back up any time soon. If anything, we’ll wait and see. And it’s a long-term speculation.

That’s all for today. Thanks for reading.

Byron W. King