PETER HAMBRO: How to buy gold at a discount

At the current gold price of $2,733 an ounce, a single 400 troy ounce “big bar” will set you back $1 million, or £840,000.

In the 1960s, the late Jocelyn Hambro, chairman of the family bank, invited Her Late Majesty Queen Elizabeth II and the Duke of Edinburgh to lunch in the bank’s famous dining room.

Wanting to have a topic of conversation that might intrigue the royal couple, he arranged for Mocatta & Goldsmid, then the bank’s wholly owned subsidiary and which had been a bullion dealer since 1684, to make a pile of gold, silver, platinum and cash that It was valued at 1 million pounds.

When Their Majesties were taken to the vaults, deep within Bishopsgate, in the City of London, to inspect this astonishing store of wealth, it was an impressive sight.

In those distant days, buying a large 400 troy ounce bar would have cost $14,000 or £5,000, say $35 or £12.5 per ounce.

Wouldn’t it be wonderful if you could still buy gold at those kinds of prices?

Well, actually you can!

Not, of course, in the form of shiny bricks, so dense and heavy that it is difficult to pick them up with one hand, nor in the candy-shaped 10 Tola bars that are so popular in the Gulf and in India,

To buy this super cheap gold you must buy it locally; in the place where Mother Nature so kindly put it, when the Earth’s crust cooled and the grains of gold became trapped in the epithermal veins of quartz and granite rocks.

Does this mean taking your hammer and walking through jungles, swamps or snowdrifts?

Certainly not! Gold mining companies whose shares are traded on the world’s stock exchanges can be valued by measuring their resources and published gold ounce reserves, and stock exchanges have specific ways of measuring and publishing them. Canada’s 43-101 method and the Australian JORC are the most widely accepted.

The all-in sustaining cost of gold mining (AISC as it is known) offers a good guide to how difficult it is for a specific company to reach shiny bar status.

Management capability and reputation is another crucial factor in determining the relative value of a particular gold deposit and, perhaps most important of all, is the political risk inherent in the mine’s location.

When analyzing Reserves and Resources it is necessary to think about these risks.

As a rough guide, reserves have an 85 percent chance of becoming actual gold bullion and inferred resources only a 10 percent chance.

This is why gold in the ground (GITG) is trading at a discount to the published price of gold.

The table below provides a snapshot of five major gold mining companies ranked by the best value of their gold in the ground.

Newmont, with 226 million ounces across all categories, probably only has 120.6 million ounces of GITG. But by buying its shares you are buying gold that will likely be delivered for many years at a 20 percent discount.

Smaller exploration companies present a different opportunity because they tend to be valued by less scientific measures.

The late great Julian Baring, one of the greatest gold fund managers of his generation and sadly missed by the mining industry for his innate understanding of the risks and rewards available, had a simpler valuation mechanism in his Psion handheld calculator.

He measured the ‘reserve ounces, undiscovered ounces’ and ‘blah-blah ounces’, and the owner’s ‘jib cut’. This evaluation was much faster than working with the table and probably more successful, but it was based on the same basic principles.

He was concerned about small exploration companies – which generally feed the big ones – where the important thing is the immediate potential.

The successful small player will usually be bought out at a premium by a large mining company that doesn’t want to bother with grassroots exploration. Julian called them ‘Lobster Pots’ – they’re easy to get in and hard to get out. But good lobsters are eaten.

Drilling and testing can be expensive, especially in difficult terrain, and this is a factor when deciding what to invest in.

Having the money to drill sample holes so that geology and mining experts can turn “about to be discovered” gold into reality is where the big opportunities lie for investors and where Julian specialized.

Significantly moving the stock price of a large producer requires a sudden increase in production, which is difficult to achieve, or a reduction in costs, which is even more difficult.

Whereas, for a small explorer, doubling the reserve and resource base is relatively easy for the owner of an exploration area that has been summarily explored, drilling targets identified and only drilling and testing is required.

Choosing the right one is key. London and the AIM market used to be the key in Julian’s time, but Toronto and its Venture Exchange now wear the crown. It’s easy to negotiate there.

But keep your wits about you and remember what Mark Twain said: “A mine is a hole in the ground with a liar next to it.”

Peter Hambro has over 40 years of experience in the precious metals and gold mining market. He is a co-owner of several private gold exploration properties in South America and is president and shareholder of the Canadian gold exploration firm XAU Resources.