Money Matters - Simplified

The Best Stocks for 2011: Gammon Gold


This article is part of our "Best Stocks for 2011" series where our Foolish writers pick their top stock ideas for the year ahead. Click here to see a review of last year's picks and our 12 recommendations for the year ahead. I will wrestle with this decision no longer.


Over recent weeks, I have tossed and turned (even toiled and troubled) over my top stock pick for 2011. Eager to repeat the success of my pack-devouring selection of Silver Wheaton (NYSE: SLW) for 2010 -- which has rewarded like-minded Fools with a dramatic gain of more than 140% -- I was determined to identify the next stock that could muster that sort of one-year return.

And then I realized I had it made. You see, looking to the correct sector in the first place is half the battle. Over the past couple of years, in particular, gold and silver have stunned the investing mainstream with the strength and persistence of their ongoing bull market trend. With leveraged debt instruments continuing to fester deceptively in the shadows of fanciful accounting methods and cleverly named "legacy" portfolios -- and considering all the resulting implications both for nation-states in Europe and the 50 states here at home -- I still maintain that precious metals offer a rare form of protection from risks that have not yet been defused within this powder keg that we call a financial system.

However convenient it may have been, it is no longer permissible for those opting out of the precious metals bull market to dismiss expectations of substantially higher prices as the ravings of some misguided fringe within the investing populace. Indeed, the managing director of Barclays Capital, Paul Horsnell, sees gold reaching $1,850 during 2011. Goldman Sachs has set its sights on $1,690 by year's end. Suddenly, my long-term price target of $2,000, which I've kept unchanged for several years running, seems decidedly less controversial.

With the right catalysts in place, even a consummate underperformer like Gammon Gold(NYSE: GRS) is capable of surging dramatically to play catch-up with this advancing bull market for gold and silver.

Adversity becomes the advantage
It's a rough road indeed that leads a gold mining stock down a multi-year decline in the midst of a historic bull market for the metal. Alongside silver's whipping post Coeur d'Alene Mines(NYSE: CDE), Gammon Gold may be one of the least-loved stocks in the precious metals patch. For many, the 2010 closure of the El Cubo mine (following irreconcilable labor disputes) may have added the final straw to a continuum of justifiable frustrations.

For this bargain-seeking Fool, however, the El Cubo debacle yielded a massive distraction that I believe prevented the market from evaluating a vast array of positive achievements for the company during 2010. These achievements form the core of an exciting turnaround story in the making and recently led me to place Gammon Gold at the pole position of my top-ten gold and silver stocks for 2011.

Gammon's bread and butter
It was precisely Gammon's prowess on the exploration front that led me to build an initial position several years ago, so I find it fitting that Gammon's recent exploration success forms a core of my updated investment thesis. During the first half of 2010 alone, Gammon discovered three new deposits at its Ocampo gold and silver mine, and it swiftly replaced nearly two-thirds of estimated 2010 production with 127,750 gold-equivalent ounces (GEOs) in new reserves. One of those three deposits, Santa Eduviges, has been fast-tracked for development, and production is expected to commence any day now.

This month, Gammon's year-end exploration update included four more newly discovered veins at Ocampo. El Rayo, just 100 meters from existing underground infrastructure, looks particularly promising with concentrations as high as 33.29 (gold-equivalent) grams per ton (gpt). Thanks to Gammon's enhanced development capacity (now that El Cubo resources have been reassigned to Ocampo), several newly defined deposits may be mined as early as mid-2011. Beyond the Ocampo camp, Gammon has moved to test the district-scale potential of the region by securing strategic option agreements for highly prospective nearby properties.

Gammon's growth capital
Capital Gold
's (AMEX: CGC) board has unanimously endorsed Gammon's proposed merger, and in this Fool's view, the pro forma company emerges as a titan among the smaller mid-tier gold producers. Capital Gold's El Chanante mine will double Gammon's gold reserves to 3 million ounces -- apart from Gammon's existing trove of 66 million ounces of silver. Using robust silver production as a by-product credit, Gammon sees pro forma production averaging 230,000 ounces of gold per year for 2011 and 2012 at a jaw-dropping production cost of $78 per ounce.

As of Sept. 30, Gammon held a cash balance of $107 million and carried a debt-to-equity ratio of just 3.7%. Between that capital strength and the prospect of a Capital Gold merger, I see a golden opportunity for Fools to capitalize upon one of the industry's most promising turnaround stories. A forthcoming preliminary assessment of Gammon's Guadalupe y Calvo project, a cementing of the Capital Gold merger, and impressive reserve expansion from that successful 2010 exploration campaign could all provide dramatic upside catalysts during 2010.

Sure, Yamana Gold (NYSE: AUY) could yet prove the greater bargain of the two, and the potential for silver to outperform even gold could propel small-cap silver stand-outs like Endeavour Silver (AMEX: EXK) and Alexco Resource (AMEX: AXU) to the pinnacle of the sector's scoreboard. That's why my own precious metals portfolio contains them all! Given the unique combination of persistently negative market sentiment with an impressive succession of overlooked upside catalysts, however, I encourage Fools to select Gammon Gold as their top stock pick for 2011.

© 2010 UCLICK L.L.C.