Stock Quotes in this Article: ABX, GDXJ, GG, RGLD, AUQ

NEW YORK (Stockpickr) -- Thanks to a strong upward move in recent months, gold prices are back up around $1,700 an ounce, not far from the $1,900 peak seen in the summer of 2011. For anyone who has owned gold since it traded for just $1,100 an ounce at the start of 2011, these have been happy times indeed.

The same can’t be said for companies that mine gold. These miners have traded down from their highs on concerns that rising costs will crimp profits. Yet concerns about mining profits increasingly appear overblown.

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Though production costs had been rising in recent quarters, they now appear to be leveling off. And at current levels, their expenses still ensure ample profits, assuming gold prices hang in there around $1,700.

Here are five gold mining stocks that look like solid bargains, with considerable upside even if gold prices themselves fail to rally further.

Barrick Gold

Any gold mining portfolio needs exposure to Barrick Gold (ABX), which is the world’s largest gold producer, with 26 mines spread across the globe. Despite its massive heft, investors soured on the company’s lack of discipline when it came time to measure investments in each mine for its potential return.

In June of this year, management decided to bring in a new CEO, Jamie Sokalsky, and he’s begun delivering a better message to investors: Barrick will focus on lowering expenses, reducing debt and returning to its role as one of the industry’s most profitable producers. At a recent mining conference, Sokalsky told investors to expect Barrick’s mining costs to drop from a current $575 per ounce to the $500-to-$525 range over the next few years.

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Those expense reductions are largely stemming from a pair of new lower-cost mines in the Dominican republic and along the Argentinean/Chilean border. Assuming gold prices remain at current levels, Barrick stands to earn more than $1,000 per ounce of mined gold -- before overhead expenses are accounted for. The drop in production costs should set the stage for operating cash flow to rise from around $4.4 billion this year, to around $6.9 billion in 2014, according to analysts at Citigroup, who see shares rising from a current $39 up to $50.

Goldcorp

While Barrick’s Sokalsky focuses on cash flow through lower costs, Goldcorp (GG) interns to boost cash flow by sharply boosting production. The company hopes to boost its gold production 70% over the next four years, to around 4 million ounces annually. Goldcorp’s costs are bit higher than Barrick’s -- around $625 per ounce -- but surging volume should still equate to a steadily rising bottom line.

Goldcorp is also one of the financially stronger players in the industry, with $1.2 billion in cash at its disposal. That should be enough to complete its existing capital spending programs and make a series of acquisitions of smaller gold miners.

Royal Gold

Colorado-based Royal Gold (RGLD) began raising funds in 1990 to invest in other firms’ gold mines, and the strategy has paid off handsomely. The company’s stream of royalties have steadily risen over the years, thanks in part to rising gold prices.

So what does the company do with all those royalties? Roughly 30% is paid out as dividends, and the rest goes right back into the next crop of mines. Royal Gold has an interest in more than 20 mines still in development, and another 100 that may get developed in the next few years.

In mid-October, Royal Gold reloaded its balance sheet by raising another $472 million in cash, boosting the company’s current firepower above $800 million. Based on current plans, analysts think Royal Gold’s free cash flow will surge from $162 million in fiscal (June) 2012 to around $400 million by fiscal 2015.

AuRico Gold

Thanks to labor problems at a key mine in Mexico, mid-sized gold producer AuRico Gold (AUQ) saw its shares take a deep hit in early September as management conceded that production would need to stop until the labor issues were resolved. Rather than deal with protracted labor problems, management decided to sell the mine, known as Ocampo, and re-invest the proceeds of the sale in to more productive mines.

That is expected to help fuel a production surge. AuRico expects to produce 268,000 ounces of gold this year, 296,000 ounces in 2013 and 367,000 ounces by 2014. Before that can happen, though AuRico will be spending heavily to set the stage for higher production.

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Capital spending is likely to exceed $400 million this year, leading to a free cash flow drain of around $250 million. Yet by 2014, with the investments largely complete, capital spending should drop to around 4125 million, setting the stage for a robust $300 million in free cash flow. The company expects that level of free cash flow to be maintained in subsequent years (assuming gold prices stay constant), which equates to an effective long-term free cash flow yield of nearly 10%.

A quick word about senior and junior gold miners. Firms such as Barrick Gold and Goldcorp are considered to be senior miners. These firms have considerable production output and their stocks are value in the context of cash flow generation. The junior miners, in contrast, are early-stage mine owners that have acquired potentially valuable mines but have yet to fully ramp up production. As a result, these firms are measured in the context of their assets, and not their cash flows.

Why take a chance on junior gold miners if they are absorbing ongoing losses? Because investors tend to discount their value while mine development gets underway, and if the mines turn out to have a mother lode of gold, then the company’s stock can soar far higher.

Market Vectors Junior Gold Miners ETF

Most junior mining stocks are too small for many investors to consider. Instead, it’s wiser to focus on owning a basket of them with the Market Vectors Junior Gold Miners ETF (GDXJ) , which is now a deep bargain after sliding from $40 in the spring of 2011 to round $23.

The fund typically owns gold miners with market values below $1.5 billion and production levels of less than 300,000 ounces per year. These smaller miners have typically become acquisition fodder whenever the big miners need to step up their growth plans.

To see these stocks in action, check out the 5 Gold Mining Stocks With Major Upside portfolio.


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At the time of publication, author had no positions in stocks mentioned.