Northgate's Hedges

Silver Stock Report

by Jason Hommel, April 8, 2006

Northgate's Hedges (Amex: NXG.  Toronto: NGX)

Northgate Minerals
Share Price: $2.57
Market Cap: $551 million.

Regarding my previous emails this weekend:

Northgate's shareholders and investor relations staff have quickly updated me on the status of their hedge book.  I knew their hedges were small, and that it will not pose much of a problem for Northgate to close it out, and so my quick and dirty P/E analysis, showing Northgate has a forward looking P/E ratio of about 3, ignored it.    

My error in thinking such complete data on the hedge book was unknowable, stemed from the fact that the laws do not require such disclosure, and my experience is that the best analysts in the world still do not know the precise price of the gold hedges of Barrick gold--the largest hedger in the industry.  Barrick may have about 18 million ounces of gold hedged at about $300 to $350, but nobody seems to know for sure, because Barrick will not say, and does not have to say.  Barrick's hedges are potentially toxic, potentially leading to the bankruptcy of Barrick, and may represent a mark-to-market loss of about $250/oz. x 18 million, which is about $4.5 billion lost profit opportunity, or an approximate "cost" to close out the hedges at today's prices, that is, if it were even possible to buy back 18 million ounces of gold in the futures market without moving up the gold price!  Barrick said they would close out their hedge book several years ago, and have been waiting for gold prices to "dip" ever since about $300/oz. for gold.  Today, it may well be impossible for them to close their hedge book.  Gold never dipped, and the hedges were never closed.  Then, recently, Barrick acquired the other major notorious hedger, Placer Dome.  They say that Barrick is "broke", and Placer Dome is "doomed".  When they go belly up, the mining industry should be quick and ready to acquire the mines they will be auctioning off.  But buyers of the mines ought to beware that such mines have likely been highgraded and stripped by a desperate and dying gold producer.  If anyone on my email list owns Barrick because they want to own "a producer", they should strongly consider selling it for a stock like Northgate, a stock with much smaller hedges, and a much better P/E ratio.

Northgate Minerals (, unlike most miners, goes beyond what the law requires, by regularly providing shareholders details of their hedges, as follows:

From the February 23, 2006 press release.

At December 31, 2005, Kemess Mines Ltd. had forward sales commitments with major financial institutions to deliver 139,000 ounces of gold at an average accumulated price of $307 per ounce.

Northgate has stated many, many times that they will not be hedging any additional gold production.

From the January 17, 2006 press release:

“In order to fix the price for copper it has already produced, Northgate entered into forward sales contracts prior to year end which locked in a price of $1.98 ($0.03 per pound higher than the average LME Cash price for the quarter) for all copper revenue that will be recognized in the fourth quarter of 2005. As a result, copper revenues that will be reported in the Corporation’s 2005 financial statements (scheduled for release on February 23, 2006) will not be dependant on future prices as is normally the case. Northgate’s copper production from January 1, 2006 forward remains un-hedged and fully levered to future changes in the price of copper.”

My comments again:

Unlike Barrick's hedges, Northgate's hedges are not that crucial to evaluating the overall picture of the company, but they do have a slight impact, as follows:

The gold hedge of 139,000 ounces is 43% of the projected production for 2006 of 320,000 ounces.  At $600/oz. for gold, 139,000 ounces hedged at $307/oz. is a missed opportunity of $297/oz., times 139,000 ounces is a missed $41 million.  So, earnings may be about $41 million less than they could be (320,000 oz. x $600/oz. = $192 million - $40 million = $152 million), and this will create a slightly higher P/E ratio until after the hedges are closed out.  As follows:  $550 / $152 = 3.6  P/E ratio (forward looking, estimateed annual for 2006), based on a cost of $0/oz. of gold production, and with gold averaging $600/oz.

Further, with copper unhedged, and with gold production costs near or about $0/oz. due to the copper credits, Northgate is not in any trouble due to the hedge book loss (or missed opportunity).

A bigger issue with Northgate is the mine life, which is about 3-4 years.  They have an additional project to the North, which will cost $200 million to bring to production, and needs a permit, that can extend production to 10 years.  Projected profits show that Northgate will not need to engage in any further dilution (selling stock) to raise this money to expand production.  Further, they have another project that they will be drilling, and they are looking to acquire another producing mine.  They have been successful, so far, and are in great financial shape to further increase shareholder value.

In sum, Northgate is the lowest cost gold producer out there (making slightly more off the copper presently). 
Northgate is mildly hedged which will not pose a problem. 
Northgate has the best forward looking P/E ratio of existing producers (about 3.6). 
Northgate has good profit potential right now ($150 million/year, or more with rising gold and copper prices) and cash on hand ($40 million).
Northgate has a good mine life (4-10 years) with good projects ahead of it.
Northgate's stock is cheap, and under-promoted. 
Finally, Northgate's stock is very liquid, and easily tradable. 

I think the stock is a solid buy until about $3.50 to $4.00/share at which point the stock will have a P/E ratio of about 5, which is still very cheap for the industry, which averages about 10 for copper producers, or about 30-80 for gold producers.  The stock could easily hit between $8-24/share over the next few years, if gold is flat at $600.  But with gold likely to go much higher, the stock of Northgate is poised to rise much higher, proportionally, as well.

If you know of a larger copper/gold producer, with a lower P/E ratio, I'd love to hear about it.  But I suspect none exist.  So far, others have only mentioned to me explorers, or near-term, "soon-to-be" producers, with lower grades, and slightly higher market caps for their value.

The cheapest and largest exploration stocks that I know of that are near term producers, with reliable high-grade resources, is Metalline Mining (Zinc and Silver) (MMGG.OB), and with reliable high-grade reserves is Idaho general mines (molybdenum) (IGMI.OB).

Finally, for those who have recently criticized my reports:  Thank you for all of the wonderful information and corrections.  You have definitely helped the quality of the information my readers have received this weekend regarding Northgate.  Despite the inaccuracies of my presentation of Northgate, the overall picture of Northgate that I presented in my first email, is mostly unchanged--it has a very low P/E ratio, probably the lowest for a company its size or bigger!  From my perspective, it is most important for me to point investors in the right direction, to a good company that will help them make money.  I try to see the forest, the big picture, not analyze the bark on the trees.  My job is to promote, and educate, not to drown my readers in detail, for if I did that, then who would read me?

Yes, research well the companies you buy--especially from promotions like this one.  But also, you need to keep in mind to look at a wide number of companies, to be able to compare across the industry.  All companies seem to have a certain "unique" bonus that nobody else has.  It's my job to avoid getting too charmed by company specific details, and instead, to compare across many companies, on measures that they have in common--as well as follow the broader market for gold, silver, and copper prices.

I have a hard job, and my many readers and critics definitely help me to provide a better service.

From my perspective, Northgate would do better to focus on the larger implications of the nature of gold, the nature of paper money, and the nature of the gold market, and the nature of the silver market, and to focus more on marketing.  For example, Northgate could denounce the futures markets in gold as manipulative and fraudulent, and expose their evil bankers who are making nearly 100% off of their "forced" gold hedges.   Northgate could be trying to convince buyers of gold and copper futures contracts to spend their cash by buying their company stock, instead.

Then again, the beauty of the free market is that it encourages specialization and the division of labor.  I do my job, and Northgate does its job, and hopefully we will both do it well.  The nature of the free market is that stocks that are under-promoted, naturally come to the attention of promoters.  The other beauty of this "job" that I have is that Northgate does not have to pay me for my services, and neither do my readers.  (Although I do offer a paid "look at my portfolio", and although I pay to advertise my services, this email is free.)  The free market is truly an amazing thing, and its charms have definitely captivated me!

It is my goal to understand the nature of the free market, and to use the competitive nature of the free market, to produce the best newsletter the free market has to offer. 

Disclaimer:  I own NXG, MMGG, and IGMI, and no company has paid me to send out this email.