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Gold is Real Money, and when Gold and Gold stocks fail to live up to Bullish expectations, investor disappointment runs very high

Over the past 10 yrs or so as an investment in Gold bullion performed 30% better than the largest Gold miners in the industry. Historically, companies that mine and produce Gold rise as the price of Gold rises.

But, beginning in Y 2002, the Gold price has risen 446%, but the benchmark index of Gold-mining stocks, the NYSE Arca Gold BUGS Index NYSEArca:HUI is up only 344%. Plus, Gold bullion has outperformed mining companies by 5-to-1 since January 2010.

The reason, most miners sacrificed profits for growth.

These companies had minimal competition for Gold-investing dollars. You may recall that before Y 2005, the only way to invest in Gold was to buy bullion or buy Gold-mining stocks.

Investors reward companies that grow by valuing businesses on the size of their reserves, the Gold miners grew.

Here is the rub, the miners main focus was not to run profitable mines, but to tapping as much of that investment capital as they could. I did not matter if a mining project could ever turn a profit, what matted was adding to the reserves, and so many companies overpaid for marginal assets.

Below is an example from an analyst that I reviewed Friday that points out the Gold is Real Money;

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From Y 2005 to 2011, Agnico-Eagle NYSE:AEM added 8-M ounces of Gold to its reserves, an impressive 80% raise from its Y 2005 reserve total of 10.4-M. It also grew production by 308%.

That looks great yes, especially when you factor in Gold’s run from $425 to more than $1,500 oz during that time frame.

That should be sound business right, growing Gold production, as Gold prices rise to record prices.

The chart below shows how well investing in growth worked out. It shows 2 Key measures of Agnico-Eagle’s business; profit margin and return on invested capital ROIC.

Agnico-Eagle sacrificed profit for growth

Yes, the profit per ounce looked great in Y 2006-2007, the bad number in this example is the ROIC. This simple measure shows us how much profit a company makes from the money it puts into the business.

Agnico-Eagle’s ROIC is in the single digits, hitting a low of 3% in Y 2011, Grim!

As Gold prices drove North, Agnico’s acquisitions were low-margin businesses, meaning, properties that cost a lot of money to mine.

About 50% of Agnico’s reserve growth during that frame came from a Fagship acquisition, the Meadowbank mine. In Y 2007, Agnico-Eagle acquired Cumberland Resources, which owned Meadowbank, for CAD$710-Meadowbank was seen as a low-cost Gold producer in the Nunavut region in far Northeastern Canada.

When Agnico evaluated Meadowbank for acquisition, the company projected mining costs at $224 oz, comfortably below the average price of Gold at the time at $604 an ounce. The truth is that the mining costs there run around $1,040 oz.

A major reason is the location, as transportation is a Key component of production cost, and transporting Gold from remote Nunavut is expensive in the extreme.

Another reason is that Agnico thought the mine would help raise its Gold production to more than 1.3-M ounces per year by Y 2010, it did not happen. The company produced 990,000 ozs last year, short of its goal.

In Q-4 of Y 2011, the company wrote off $604-M on the project, that friends is 85% of its initial acquisition price 4 yrs prior.

That is $604-M of shareholder money gone. This is showing in the price of the company’s stock.

Over the last 5 yrs, Gold has more than doubled in price, and our Gold miner, Agnico shares are up just 10%.

Agnico is not the only big miner involved in this activity. Many major Gold-producing companies spent the last 10 yrs acquiring and merging with each other, and pursuing growth at all costs. The result is there are now a few big mining companies burned with lots of uneconomic assets.

So, when Gold and Gold stocks fail to live up to Bullish expectations, investor disappointment runs very high.

Ten years ago had you purchased Gold Bullion Coins and locked them up in your drawer, you would have a handsome return today.