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The Great Gold Whale: A Category Killer in Alaska

NovaGold. The mine at Donlin is a potential “category killer,” in the words of the company’s chairman.

“Opportunity is tremendous in Alaska,” Willy Loman’s older brother Ben advises him in Arthur Miller’s Death of a Salesman. “Surprised you’re not up there.” The largest state in America has, at various times unlike our own, been a magnet for those for spellbound by the prospect of gold. Over three years, the great Klondike gold rush lured hundreds of thousands of formerly upstanding U.S. citizens north to Alaska in search of gold, and inspired immortal stories by Jack London and the classic Charlie Chaplin film The Gold Rush. But for gold bugs, the real action in Alaska may be just beginning.

If you are looking for a stock with high-octane leverage to gold, a CEO expert in mine-building, a chairman with a history of hitting it big in commodities, and a high-grade enormous find in the world’s safest mining jurisdiction, then NovaGold (NYSE: NG) might be up your alley. By definition, to like it, you have to love gold, but if you love gold, you’ll probably love its leverage to an increasing price of bullion. As Jim Grant points out elsewhere in the issue, there’s reason to believe that being long gold is one of the more logical plays you can make in today’s macro environment, as the printing presses of various central banks whirr and the hands and minds operating them seem to have no plan or no way to stop. Grant likes Barrick Gold (NYSE: ABX) as a way in on the yellow metal — but if you’re looking for a junior developer with more potential upside, we recommend NovaGold which, coincidentally, represents a pure play on a joint venture with Grant’s pick for what some are calling the Holy Grail of recent gold discoveries: the Donlin Gold project in Alaska.

Donlin was first discovered by NovaGold when the company was under the leadership of Rick Van Nieuwenhuyse, an award-winning geologist. Geological studies to date already show proven and probable reserves of 34 million ounces of gold, a figure that jumps to 39 million in terms of measured and indicated resources and 45 million ounces including inferred resources. The mine is a whale, with a projected annual output of 1.5 million ounces during the first five years of its life and a lifetime annual output of 1.1 million ounces. It’s also worth noting that Donlin is likely to contain a lot more gold, a fact that should be confirmed once the owners can turn their attention back to exploration. (This has been suspended during the permitting process, which is still ongoing.) There are several reasons for this optimism. Firstly, Donlin’s contained within just three kilometers of an eight-kilometer-long gold-bearing trend, and secondly, the in-pit area of the mine covers only approximately two percent of the 80,000-acre land package the property comprises. The sheer volume of the resources at Donlin put the project squarely among the largest in the world, an anomaly at a time when gold discoveries are getting rarer and more expensive to find. In fact, 2012 saw precisely zero new discoveries, anywhere — period. And technical innovation won’t fix this decline, either: gold is where it is, and no genius is going to unlock it with a mineral version of fracking.

Size is only part of what makes the Donlin deposit unusual. Its other distinctive characteristic is its remarkably high grade. Once the mine is up and running, the company expects to be digging up gold with an average grade of 2.24 grams per tonne — 2.5 grams in the first five years — more than double the average grade of one gram (and falling) for projects currently in development. There’s also the fact that NovaGold would be able to get the gold out at an all-in sustaining cost per ounce of $735 life-of-mine, very low relative to other comparable projects.

Despite its most valuable asset being located in Alaska, a very safe jurisdiction and thus a rarity for gold finds of this caliber (which normally face major jurisdictional risk), NovaGold has a colorful history. After inheriting half of the project when it acquired Placer Dome, gold major Barrick made a hostile takeover bid for NovaGold in 2006 at $16 per share, recognizing even then the enormous potential of its flagship asset. NovaGold’s stockholders rejected the bid. It was a somewhat pyhrric victory at the time for NovaGold, however, as litigation at another project and a massive increase in projected development costs caused the stock to crater. The company stood on the verge of bankruptcy in the post-Lehman financial crisis. Then, in 2009, it was rescued by the Electrum Group, the vehicle for the commodities investor Thomas Kaplan (interviewed elsewhere in this issue) which acquired 27 percent of the company’s shares at around $1 per share. Thus began a multi-year process of restructuring and refocusing NovaGold. The company’s litigation was settled and two successful financings were undertaken — first to George Soros and John Paulson at $5.50 per share and then a larger offering at $9.50 per share — that ensured the company would be fully financed until a construction decision. A mega-copper project was spun off to shareholders as NovaCopper, with Van Nieuwenhuyse at its helm, and a new CEO was recruited — none other than Gregory A. Lang, the head of Barrick’s North American division and the man who had overseen the Donlin project for the former predator. Lang, a 30-year industry veteran, has tied his fate to that of NovaGold, representing a career bet on the viability of Donlin. He specializes in mine-building — exactly the right experiential profile one would want to see in the executive of a company trying to get a project as massive as Donlin built. Finally, as part of the restructuring, the company also put up for sale its interest in Galore Creek, the largest undeveloped copper mine in Canada, to focus entirely on the Donlin project and put to rest the market’s concerns about its ability to finance two mega-projects at once. And against this backdrop, the company has slowly but surely advanced the project.

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.

So there you have it. NovaGold looks like a cheap ticket to a fancy party for the roaring bullion bulls out there. Plenty of reason to consider a play on the massive and rich Alaskan asset it’s bet big on. And you don’t even have to strap on your snowshoes or heft a pickaxe to do so.