Sunday, January 4, 2015

Speculating on a recovery in Sandstorm Gold

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 Gold and gold mining shares are currently one of the most maligned unloved industry segments. That has my contrarian senses buzzing as that is where the value usually exists. I think gold is due for a bounce early in 2015 just based on how oversold and unloved it is now. However we have seen oversold and unloved conditions in the gold market and gold stocks which then proceeded to make even lower lows. I think buying Sandstorm Gold is a way to participate in a rally in gold and gold mining shares while protecting oneself against further weakness. Sandstorm is not a mining company it is gold royalty/streaming company. Basically the business model is to provide financing to gold miners for a portion of the future gold production which they get to buy at a substantial discount to the current gold price. The gold royalty/streaming business is dominated by larger companies such as Franco Nevada and Royal Gold.

Readers will note that both Franco Nevada and Royal Gold have held much better than most gold stocks even in the midst of all of the negative sentiment. That is because as long as mining is taking place on the properties where their royalty streams are located they get paid regardless whether the actual mining company makes money. That is the beauty of the royalty model. I will grant that these will not be 100-1 moonshots like junior miners can sometimes be but these are steady money makers with high margins. If bought at the right time, like now when they are out of favor, they can lead to market beating returns.

Sandstorm is a lot smaller and is not as diversified as the larger companies in its space. This is what led to their recent share price weakness. The company has a large vested interest in Luna Gold's Aurizona project and after some major rains production was seriously affected to the point where the streaming deal with Luna Gold was almost renegotiated. However this did not happen and Sandstorm has now become, through participating in private placements, Luna's biggest shareholder. The company has changed management and has implemented a cost cutting initiative to lower costs in this low gold price environment. The board of directors has also initiated a strategic initiative with the intention of maximizing shareholder value. I think there is risk here, especially if the gold price continues lower, but it appears sandstorm has stepped in and is stabilizing the situation.

The management of Sandstorm Gold thinks that there shares are undervalued and initiated a stock buyback in December 2014.What I really like about this company is the optionality it gives at a cheap price. What I mean is that typically these royalty companies usually negotiate a royalty on any further resources that are discovered on the properties where they have existing royalties. Sandstorm does not have to spend anymore money yet gets the upside of any discoveries made. As Pierre Lassonde the founder of Franco Nevada said about optionality,if you control several million acres of prospective land don't you at some point get lucky? yes you do. So the bottom line is we have a profitable gold royalty company that stumbled a bit and has now begun to right the ship. They have $90 million in cash and are buying back shares. My feeling is that gold is the most oversold and unloved as it has been in years and we still have most central banks debasing their currencies. Textbook contrarian setup in my view. Sandstorm Gold is being added to the speculative portfolio. I was actually buying this last week and the stock jumped 10% on Friday so beware this thing has already moved significantly and could pullback before moving higher. 

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