Last week on thebull.com.au the Broker Buys column highlighted gold mining/exploration share Gryphon Minerals (GRY), a company that has yet to produce one dime in profit.  Yet, seven of Australia’s top brokerage firms have buy ratings on this speculative company.  

If you have been involved in share market investing for the last five years or more, you know the price of gold has skyrocketed.  As the price reached stunning new highs, a few experts chimed in, warning of a bubble.  At $900 per ounce, how much higher could it go?  Quite a bit, actually.

Today it is at around $1600 per ounce and many see more upside.  Historically, investors have flocked to gold as a hedge or safe harbor in troubled waters.  Here are some of the factors that define “troubled waters:”

•    Economic crises

•    Secular bear markets (3 to 5 year duration)

•    Political gridlock

•    Currency devaluation

•    Unsustainable sovereign debt

•    Inflation

•    Social unrest

•    War

To support a case for a continued rise in the price of gold, one would have to consider each of the above factors carefully to assess the likelihood they are still present and will continue.

While global economies have recovered from the Great Financial Crisis, in most countries the recovery has been sluggish at best.  Hardly a day goes by that you do not read of some European nation in danger of defaulting on its debt.  One day it is Greece, then Portugal, then Spain, then Italy, and now, even the United States.

The future of the Euro and indeed the survival of the Euro zone itself are up for debate.  The Chinese are raising interest rates to control inflation while the United States is expected to maintain low interest rates until their economic recovery, which appears to be on life support, takes hold.

Social unrest is rampant throughout the Middle East, where a substantial portion of the world’s oil production lies.  

What more do you need to know?  Although you can make a case for continued interest in investing in gold, why should you invest in a gold mining and exploration share, as opposed to a fund that holds gold bouillon or funds of gold mining shares?  

Spend a little time researching the issue on the web and you will learn some experts feel if there is a bubble, it is more within ETFs than in individual shares.  You will also learn a gold mining share with growth potential stands to benefit twice from a continuation of the gold bull market – once from the price of the commodity and again from the concomitant rise in the share price.  

The second advantage only holds true if the miner is a well run company with real growth potential.  So how does GRY stack up?

With a speculative share like GRY that has yet to turn a profit, the numbers you can rely on to evaluate the share are limited.  With no profit there is no Price to Earnings ratio and on and on.  In reality, there are only three numbers that matter – debt, cash on hand, and burn rate.

With any speculative buy you have to think of the company as engaging in a race against the clock.  Their operating capital comes from financing or issuing equity and if they do not start showing a profit before the money runs out, they have to back to the well for more cash or go out of business.  

One impressive feature of GRY is that they have no debt.  They have not borrowed a dime recently to operate, relying instead on issuing shares.  So just how much cash do they have on hand and how much of a safety cushion does it provide?  From the company’s website we have reproduced a portion of their half year statement of cash flows:

The bottom line tells the tale – over 61 million dollars cash on hand.  You can see they carried over 19 million from the previous period and raised about 52 million in an equity raise during the year.  

You may recall from the Broker Buys column, GRY made a significant acquisition during the year, absorbing another gold mining and exploration company, Shield Mining.  Although they paid out $2,538,518 to acquire Shield Mining, they also absorbed that company’s cash position of $4,335,492.

Although 61 million sounds quite healthy, the number is meaningless until we know Gryphon’s burn rate – how fast is it losing money – and to a lesser extent, its projected start date for revenue and profit generation.  

There is a complex way to calculate the burn rate and an easy way.  First, you need to know the company’s total loss for the accounting period, minus one time charges.  From the Statement of Comprehensive Income on the GRY website we learn the number for the period was (11,280,465.)  We divide the cash on hand -- $61,360,977 – by the yearly loss – ($11,280,465) – and we see the company could continue to operate at present levels without the need for any kind of capital raise for 5.5 years.  That is a very healthy cushion.  

The complex way is to first divide the yearly loss by 12 to get a monthly burn rate -- $940,038 in our case – and then divide the cash on hand by that number.  The result here would be 65.3 months.

GRY has an admirable cash position.  From a news search, we learn they expect production to commence in 18 to 24 months.  As far as an assessment of potential goes, let us first let the market speak.  As you know, issuing shares often leads to an immediate drop in share price that can persist for longer than you might think.  

First, we search the news announcements for GRY on their website and we learn the offering was for $1.25 per share, and they had more buyers than they had shares to sell.  In addition, 70% of their investors are major institutional holders.  The big boys like GRY.  And so does the market.  Here is a 2 year price chart, showing movement during the time of the equity offering:

Although the market and the analysts are high on this company, there are a few more things we want to know.  First, the analysts and our search of the company website indicate they are well positioned in major gold exploration areas in Africa.  One thing some newer retail investors forget when looking at mining shares is the cost of getting the product to processing and distribution facilities.

In addition, what is the political stability of the country and the local government’s view of the mining operation?  From the Deutsche Bank analyst report on the GRY website we learn the following:

•    Once production begins, the government will take a 10% free carried position in the company.

•    GRY would pay 3% royalties

•    There is adequate infrastructure in the area, including water, power, and transportation access.

•    Mining is an emerging industry in the country and the government is proactive in its support.

Gold is a scarce resource and with demand increasing, we wondered about available supply.  We learned what some retail investors do not know – supply is dwindling.  The World Gold Council says since the first nugget was mined, only 165,000 tons of gold have been extracted from the earth.  They claim current mining estimates show only 26,000 tons still remaining to be extracted.

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