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Mining Service Companies Set to Lead the Gold Bull Market

September 27, 2012 | About:

Most investors know that gold has been the best investment over the last decade. From around $250 an ounce to $1,750 an ounce, it has been a spectacular ride for gold bullion investors. However, most investors also know that gold stocks have languished. Even as the price of bullion has skyrocketed, miners have had a difficult time capping their costs of production. It now costs about $1,100 to produce an ounce of gold.

While reviewing some facts about the gold bull market from a recent presentation by Pierre Lassonde, I discovered that the industry is going to have to do a lot of exploration over the next decade. First, the time to bring a mine to production is about 15 years. This is most likely due to increased environmental opposition to mining. Second, it is becoming difficult to find massive deposits. For example, since 2006, the total gold discovered has been less than 40 million ounces per year. Clearly, when you put these two trends together you set up a classic problem of supply and demand.

Most investors think that the best way to capitalize on the supply squeeze is to buy junior gold stocks. The problem with this strategy is that most junior exploration stocks are worthless. The probability that a junior finds gold and brings the discovery up to production is about 1/3000. The probability that a retail investor identifies and invests in the winning junior stock is almost zero.

Thus, the safest way to invest in the coming exploration boom is to focus on mining service companies. For example, Major Drilling (MDI.TO) currently trades for $10 a share. The company has been hammered, as most investors are fearful of a slowdown in base metal drilling. However, MDI generates 47% of its revenue from gold drilling. Only 1% of revenue is generated from iron ore. In fact, 18% is generated by copper, 6% zinc, 5% energy and 5% nickel.

Seventy-four percent of their client base is senior intermediate mining companies. In other words, the company does not have a lot of credit risk with junior companies.

The company is conservatively financed with only $15 million of debt. Major Drilling also has a book value of $6.65. Investors basically can buy their $1.22 in earnings for $3.30.

The safest way to invest in the coming gold exploration boom is with a mining service company like Major Drilling.

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