Gold Shares Steady, “A Far Better Bargain than Bullion”

Gold shares held steady Friday morning as the AMEX Gold Bugs Index (HUI) traded near unchanged at 561.16.  The stability in gold shares coincided with a fractional move higher in COMEX gold futures, which advanced $4.50, or 0.3%, to $1,724.70 per ounce.  The yellow metal held firm as the U.S. dollar dipped 0.3% against a basket of foreign currencies.

As regular readers of GoldAlert are well aware of by now, gold shares as a group continue to lag the price of gold by a wide margin.  On a year-to-date basis, the HUI has fallen 2.1% – compared to a 21.3% gain for the yellow metal.

The latest market pundit to comment on the sector’s underperformance was Christopher Barker, a contributor to The Motley Fool.  In a though-provoking article entitled “The Remaining Bargains in Gold,” Barker argued that it is only a matter of time before gold shares begin to outpace the gold price.

Barker raised the topic in light of China’s Shandong Gold Group’s $1 billion bid this week for Jaguar Mining (JAG), an emerging mid-cap gold producer.  The offer propelled shares of JAG higher by 44.7% on Wednesday, and generated considerable discussion about the prospects for future merger and acquisition activity in the gold sector.

The key aspects of Barker’s piece are presented below in their entirety, with bold emphasis added by GoldAlert:

If this offer carries a singular message to resource investors, it’s that untapped mineral resources and reserves are just as critical to deriving fair value for mining shares as are the near-term cash flow and earnings metrics that typically drive near-term market sentiment. This won’t be the last time we see a gold deal proposed at a 70%-or-higher premium; not only because competition for quality assets is likely to grow quite fierce, but also as a reflection of the market’s longstanding failure to properly assess the value of mineral resource inventories within its process of price discovery. This is one reason I consider mining shares a far better bargain than bullion at this stage of the bull market cycle. Of course, forward price expectations for the underlying metals also come into play, and here again I perceive a market that has collectively and systemically failed to anticipate the most likely long-term price scenarios for precious metals.

I’ll take it a step further and point out that even reliable exploration upside and exploration successes that have yet to find their way into a 43-101-compliant resource belong at the table among the many  factors to consider when assessing valuations of mining stocks. The market, I maintain, has failed to adopt such a nuanced approach to the industry at large, and therein lies the opportunity for long-term investors to find ultra-deep value where those failures are most evident.

Jaguar offers a fine case in point, since even the reported $1 billion offer equates to just $235 per ounce of gold in reserves. Newmont Mining (NYSE: NEM) , meanwhile,  coughed up $538 for every ounce of measured and indicated gold that Fronteer Gold had amassed before that deal. Although part of that disparity relates to Newmont’s anticipation of further exploration upside on the acquired properties, the disparity is nonetheless punctuated by the fact that Jaguar is an established producer with three operating mines.

Claude Resources (AMEX: CGR) offers another prime example. Operating only a single small-scale mine that is expected to yield less than 50,000 ounces during 2011 at elevated operating costs, the miner garners little fanfare from an indifferent equity market.  But the market’s assigned enterprise value of $264 million for the company enters purely ludicrous territory when the rapidly expanding scale of its high-quality resource base comes into view. With 928,000 ounces of high-grade gold indicated at its Madsen project so far — and 921,000 more ounces of gold-equivalent at the bulk-mineable Amisk deposit — Claude is quietly amassing riches that remain wholly overlooked by a short-term and earnings-obsessed equity market. Claude’s combined indicated resource plus reserves total 2.26 million gold-equivalent ounces, resulting in an enterprise value of just $117 per ounce (excluding inferred resources!). Not even the company’s eye-popping discoveries to expand the resource at its existing Seabee mine have managed to move the needle, and the result is a stock that I consider among the industry’s premier bargains.

Quality non-producing explorers like Paramount Gold & Silver (AMEX: PZG) , with no current cash flow to offer, are routinely subject to even more pronounced failures by the market to realistically assess the fair value of mineral inventories. I believe that the studious Fool, who can accurately identify those assets most likely to advance into cash-flow generation by one means or another, could stand to make a fortune investing methodically in deeply undervalued precious-metal explorers.

Over time, the ongoing consolidation trend in the precious metals space will correct the persistent failure of the equity markets to adequately value mineral inventories among the explorers and miners of gold and silver. This week’s reported offer by China’s Shandong Group to acquire Jaguar Mining at a 73% premium marks another important step in that direction, but I urge Fools to mine the mining sector for similarly undervalued mineral inventories before the inevitable flurry of asset revaluations truly takes hold.