The Great Gold Whale: A Category Killer in Alaska

Things have changed with Barrick as well. Barrick spent years talking down the Donlin project precisely because they still coveted its other half. Following their disastrous acquisition of a copper mine in Zambia and several massive project overruns, a suddenly overleveraged Barrick began to suggest (the rhetoric was aimed at appeasing shareholders concerned about Barrick’s debt) that they would not in fact commit the $3 billion needed to build their share of the mine. But now Barrick’s management has completely changed its tune. The new CEO, ex-Goldman Sachs executive John Thornton, has gotten religion about Donlin, making glowing statements about it in recent months and touting the mine as a future crown jewel for the company. Moreover, both NovaGold and Barrick have stated they will not build the mine unless prices justify it. But both, of course, believe they most certainly will build it.

So NovaGold could be -- in the words of its chairman -- a “category killer” as a way to play a gold bull market. But with opportunity, there has to be risk. The first area of concern we want to point out is the question of permitting. For many years, this seemed so far off that investors avoided NovaGold because production was such a distant dream that the near-term price of gold seemed irrelevant. But now NovaGold is advanced a good way through the multi-year permitting process and seems to be heading for a successful result there with little local objection, having last year secured long-term surface rights from the local Native Corporation and being now set to file its draft environmental impact statement by year's end. For a large mining project, Donlin seems to be remarkably non-controversial, and the threat of a green insurgency looks blunted for the moment -- as do comparisons to the disastrous Pebble project, a huge but low-grade copper/gold/molybdenum mine far more environmentally sensitive that has lingered in legal limbo for decades.

The second major concern for investors in Donlin is the high capital expenditure required to get the mine online, estimated by NovaGold and Barrick to amount to $6.7 billion -- a potentially heavy lift. True, that figure includes a $1 billion contingency. And importantly, NovaGold and its partners have not repriced the lower costs of many inputs. The initial cost to build was assessed at a peak in the commodity cycle when production costs were much higher due to demand; many costs have plunged significantly since then. There’s also the possibility that NovaGold will use third-party operators to build and run the massive infrastructure necessary to get all that gold out of the ground. This would include port facilities and power generation, as well as the gas pipeline that is the biggest infrastructural hurdle. And then there is the sale of its non-core asset, its fifty-percent stake in the Galore Creek copper project. While Galore has been on the market for years, and Teck has a right of first refusal, it too is an unusually large project in a safe jurisdiction: a big value-add considering that location risk is even more pronounced for copper projects than for gold.

So the NovaGold thesis is clear: an all-in bet on a massive, high-grade mine that still has to be developed, just the type of high-risk miner the market has hated in recent years. And the volatility on this one is not for the faint of heart: the stock can move 10 percent in a day. But things look much better for the company than in 2012, when it traded at $13 before collapsing to as low as $2. Despite this possible downside, NovaGold has a lot going for it. There’s the category-busting nature of the Donlin asset itself. There’s the fact that Barrick is now fully on board. And there’s the fact that the company’s top shareholders have stayed faithful through the fluctuations of its very volatile stock price. These include legendary value investor Seth Klarman of Baupost, the third-largest holder of NovaGold stock. And not to be underestimated is the fact that unlike most other gold mines in its league in terms of size and quality, Donlin is (as noted above) located in the world’s safest geopolitical jurisdiction: the United States of America. This means that if and when Donlin goes online, people who’ve bought stock in NovaGold don’t have to worry about a coup and a subsequent surprise nationalization of the mine. It will stay in the hands of NovaGold and NovaGold’s shareholders, a fact which one day may justify a safety premium.

Last but by no means least is the stock's absolutely phenomenal leverage to gold. At current prices of $3.90 per share, including the company’s cash balance and a discounted value of $200 million for its stake in Galore, the share price seems to discount a gold price of $1,200 in perpetuity. This includes no additional upside from exploration, a bearish scenario. But our model suggests that should gold make a move to $1,400, at a five percent discount rate the value of the Donlin project hits almost $3.5 billion, giving an NAV for NovaGold including its cash of $5.68. At the $1,890 price where gold peaked in 2011, Donlin is worth $7.17 billion and NovaGold’s NAV climbs to $11.18. At a doubling of the gold price to $2,400, Donlin would be worth almost $10.9 billion, producing a value of $16.77. At the zero percent discount rate gold miners traded at before hard times for the metal set in, a move in gold to $2,500 would result in Donlin’s value increasing more than four times, from $6.2 billion to $29.6 billion, or $44.77 per share. It’s also worth noting that in bull markets for gold stocks, they often trade at premiums and even multiples of NAV, especially ones with great exploration potential and low regulatory risk like Donlin. And if we want to get totally blue-sky here and follow what Kaplan told us he thinks is the low end of an equilibrium price for gold, at $3,000 our stock valuation soars to $23.34 at a five percent discount rate and $57.20 at a zero percent discount rate. Powerful stuff.