Have Gold Miners Hit Bottom Yet? Here’s One to Watch

Sean Brodrick

The carnage in precious metals last week was awful … especially if you thought it signaled the end of the bull market.

However, if you believe this is just a bump in the road — as I do — then we’re talking about a potential set-up for a major buying opportunity.

While we await the next bottom in gold, I’m building a shopping list of undervalued miners.

Here’s one I’m keeping my eye on, and one to put on your intermediate-term radar …

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Scorpio Gold (SGN on the TSX-V; SRCRF on the Pink Sheets in the U.S.).

Scorpio is a producing gold miner in Nevada that you can buy for pennies. Here’s an interview I shot with its president, Steve Roebuck …

Direct link: http://youtu.be/Xpsy_AlMYfM

Scorpio Gold recently sported a market cap of $56.85 million. It has 125 million shares outstanding, and recently traded at 46 cents (Canadian) a share.

For the nine months ended Sept. 30, 2012, Scorpio Gold reported earnings of $10.5 million from mining operations, on revenue of $37.2 million. At the end of the third quarter of 2012, the company reported $10.6 million in working capital, and $11.8 million in inventory.

Scorpio paid off $10 million in original acquisition debt in 2012 and had a clean balance sheet going into the fourth quarter. It is cash-flow-positive and shouldn’t have to sell more shares to raise money.

This company owns 70% of the Mineral Ridge Mine, which had 131,000 ounces in contained gold reserves in its last National Instrument 43-101 filing.

It has made improvements to the mine that should boost production, including …

  • A new water well that should triple the amount of water it can put on the leach pad. A shortage of water was one of the things holding down production last year.
  • Additional mining capacity in the pit.
  • A larger crusher that will increase the throughput of the mine from 6,400 tons per day to 9,600 tons per day. This should go into operation in May.

These are all things that should boost the production of the mine. It produced 32,000 ounces of gold last year, and has given a conservative estimate of 32,000 to 35,000 ounces of gold for this year.

Scorpio acquired two other interesting projects. The first is Goldwedge, a fully permitted, operational 500-ton-per-day mill that Scorpio will use for toll-milling purposes — i.e., it will mill gold for other miners.

The company is targeting putting the Goldwedge mill into operation in the second half of this year, and that should mean extra cash flow for the company. Goldwedge comes with a mine that the company is going to assess as well.

The other purchase was Pinion, a project at the south end of Nevada’s rich, rich Carlin Trend.

Despite all this, the stock has been hammered in the past year. Take a look at the chart  …

(Updated chart)

You can see that Scorpio is in a downtrend, and trading near the bottom of its channel. There are four major forces that have pushed it lower …

1. Gold miners are hated.

Take a look at the chart below that compares the performance of the Market Vectors Gold Miners ETF (GDX) and Barrick Gold (ABX) against Scorpio Gold (shown in red, black and green, respectively) …

(Updated chart)

That’s just awful. It’s also a very similar tale of woe for all three.

2. Short Reserve Life.

That 131,000 ounces in reserves is less than four years’ worth of production. However, 80,000 feet of drilling has been done in the past year that isn’t included in this reserve and resource estimate. Those results will be included when the new estimate comes out at the end of this year.

What’s more, Mr. Roebuck says that the company is spending $3.2 million on exploration this year, which should result in MORE ounces in reserves and resources.

3. Didn’t Meet Forecast Expectations.

When the company put out a production target of 32,000 to 35,000 ounces for this year, many investors were disappointed. They expected more.

They may get more — Mr. Roebuck tells me that he’d rather be conservative and surprise on the upside. I don’t blame him. Still, the stock was hammered this year because investors were disappointed at that conservative guidance.

4. First-Year Bumps.

As I said, the company had water problems that weighed on production last year. It solved that by drilling a new well. Scorpio also had a problem with a chronically malfunctioning weightometer, which misreported how much ore Scorpio put on the pad at Mineral Ridge. That has since been replaced.

I don’t know of many mines in the world that go into production without a hitch, but investors hated this news. It came at a time when investors were already nervous as cats about miners.

So, that’s 91,000 gold ounces in reserves attributable solely to Scorpio Gold. That’s $136.5 million worth of gold at $1,500 an ounce.

Scorpio’s total cost per ounce ran at about $940 per ounce in the most-recent quarter, and should be under $900 this quarter. That’s because production is going up while costs are remaining about the same.

At $1,500 an ounce, that’s at least a $560-per-ounce profit. So Scorpio’s reserves at Mineral Ridge — even if it never finds another ounce — should be worth roughly $51 million.

So basically, the company is being priced for the value of its reserves, with no value for Goldwedge or Pinion.

There are things that give me pause, though.

The company’s deposits are low-grade. I think this lowers the chances of a take-out bid for all or parts of the company by one of the big miners.

But its deposits are profitable at current prices, and in fact its costs are lower than some big miners I can think of.

All told, I think this company works best if you don’t mind hanging on to it for a while to see what develops.

Start Making Your Own Shopping List

I think this stock is cheap. In fact, there are a LOT of miners that are looking very cheap right now.

I’m getting ready to buy. I don’t want to catch a falling knife, so I’m waiting for gold to bottom first.

When it does, I’ll be ready to rip. We banked gains recently in Red-Hot Global Resources, so we have money to put to work.

You should get your own list together. If you’re doing this on your own, be very careful. For example, Scorpio Gold is only listed on the TSX Venture Exchange in Canada and the Pink Sheets in the United States.

Some U.S. investors will find it hard to buy, and the average trading volume on the U.S. shares is just 13,000 shares a day, which is light. (The Canadian shares are much more liquid.)

So don’t buy anything you don’t understand, and be sure to have an exit plan before you make your entry.

Good luck and good trades,

Sean

Sean travels far and wide to seek out small-cap values in the natural resource sector. His journey started in New England. As a youth he worked on Mt. Washington, on the cog railroad that runs to the summit.