How To Play The Surge In Precious Metals

by: Emmet Kodesh

When I wrote my piece, "Gold may hit $1050 before rallying" it was in the expectation that there might be more shorting of gold (NYSEARCA:GLD) futures to ease replenishment of inventories drained by growing demand for physical metal. However, if this occurs it will prompt more buying and higher prices after the initial drop. Hedge funds also will want to follow commercial long positions and cover shorts they placed in following the narrative of gold and silver's demise.

Just as gold (NYSEARCA:GDX) and silver (NYSEARCA:SIL) mining companies were hit hardest by falling bullion prices, since June 27 they have been rising off post-2008 bottoms (in the case of ETFs, lows since inception). They still are the best value sector in the markets with fundamentals indicating a strong and sustained rise in the entire PM (precious metals) sector.

The core of this article will suggest several ways to play the recovery in gold, silver and PM miners and explorers. Supply-demand, industrial and monetary fundamentals have put a sturdy floor under PM prices that still are depressed. This article was drafted over the weekend and its suggestions about specific ETFs and PM companies have been verified by the action July 22 with gains, as of this revision, ranging from 5.4% - 9.91% in the issues mentioned. While the strong recovery of recent days no doubt will include pauses and retrenchment, the context for the guidance should remain intact for a good while.

Most readers know that 2013 has seen steep sell-downs in gold, silver and the miners that explore for and produce these vital monetary and industrial commodity metals. There was congruence between repeated massive short-selling of GLD and silver (NYSEARCA:SLV) futures and the need of banks to fill increasing buy orders. Indeed, the steady and accelerating plunge of the widely known and advertised ETFs and the entire sector from late October 2012 was concomitant with Germany's request to repatriate 300 tons of its gold from New York. There has been a cascade of unintended effects from the growing supply-demand imbalance: falling prices led to an explosive rise in buying of physical metal which increases the need to buy metal to fill demand.

One example of many: JPMorgan's gold holdings fell to 136k oz. in early June and 42k oz. July 19. The result will be similar to but greater than the initial short selling initiated by Goldman Sachs in April: demand will soar further as the decline of major stockpiles becomes apparent. PM prices will rise as Asian nations, warehouses and retail investors continue to buy or replenish metal holdings.

There are many good ways to play the surge in the secular PM bull market, a recovery that began June 28. In the latter part of this piece I will note major and mid-tier dividend-paying producers with multiple sites that continue to be value choices with great upside. First I note some rarely mentioned ETFs that allow additional leverage on the burgeoning recovery in a sector whose floor is buttressed by evolving monetary arrangements likely to include gold, disorder in fiat currencies as QE continues globally, ex-USD trade often involving gold and continuing high demand while supply has dwindled from ongoing cutbacks by miners in capex for E & D and upgrade or expansion of existing mines.

It is the last point, retrenchment in E & D that makes the Global X Gold Explorers ETF (NYSEARCA:GLDX) potentially the highest return speculative play in the sector. Once the mining resurgence that began June 28 gains traction and attracts attention and as physical gold (NYSEARCA:PHYS) and silver (NYSEARCA:PSLV) continue to rise, curtailed E & D will resume and accelerate. For example, development at the numerous sites that First Majestic Silver (NYSE:AG) and Eldorado Gold (NYSE:EGO) have put into abeyance will proceed as growing current output and revenues, especially at AG will support site growth.

GLDX debuted in December 2010 and for six months traded near $80/share. When the silver price lost its top in May 2011, GLDX began a steep decline that increased when gold topped in September 2011. GLDX participated in PM sector basing May - July 23, 2012 and rose to $40 that October. Since then and given its status as sector pioneer, it dropped heavier than bullion prices, miners of all sizes and streaming-royalty companies, losing nearly 75% of its value. Since the turn-around, it is up 25% from its June 27 low at $11.52, closing July 19 at $14.25. Among the largest of its twenty holdings are Paramount Gold and Silver (NYSEMKT:PZG), Asanko Gold (NYSEMKT:AKG), Rubicon Minerals (RBY), Continental Gold (OTCQX:CGOOF) and Nova Gold (NYSEMKT:NG) which partners 50-50% with Barrick Gold (NYSE:ABX) lined up to fund the rich Donlin Creek site in Alaska.

GLDX led the PM sector down, losing 85% of its share price in two years. Given the basics of commerce, demand, value and monetary changes I have discussed in previous articles, it is likely that the fund's V-bounce the past 3+ weeks will continue. While it may lag miners and streamers in the early months of the ascent as the sector strengthens and draws interest, with demand likely to increase further this E & D ETF should see explosive gains. In my view, most investors should find a place for this play in their portfolio even if as a test or experimental .3% of equities holding.

Another lesser known play set to rise in this sector recovery is the Pure Gold Miners ETF (NYSEARCA:GGGG). Containing well-known producing miners and debuting 6 months after GLDX, its fortunes have reflected more closely the sector as a whole, declining from $34 at the 3Q 2011 gold peak to its June 27 bottom at $9.31. Since then it has come 22% off the bottom to $11.27/share. While the Explorers ETF is 97% Canadian and 3% Australian companies, GGGG is globally diversified with its main country weightings in Canada (42%), South Africa (14%) and Australia (9%). China, Turkey and U.S. producers each are about 5% of the fund's holdings and Russia 6%. GGGG includes companies well known in the sector like Aurizon (AZK), Centerra (OTCPK:CAGDF), Osisko (OSKFF.PK), Kinross Gold (NYSE:KGC), Eldorado, Perseus (OTCPK:PMNXF), AngloGold Ashanti (NYSE:AU), Gold Fields (NYSE:GFI) and Harmony Gold (NYSE:HMY). Those who believe that South Africa will steady after a year of labor and political turbulence will find the fund's balance useful. The preponderant weighting in other globally diversified companies, 60% Canadian, Australian, American and British as well as mining friendly and gold hungry nations like Turkey, China and Russia should provide the benefits of minimizing single company risk.

The Junior Gold Miners ETF (NYSEARCA:GDXJ) also has surged 22% off its June 27 bottom at $32.94, closing July 19 at $39.28. At the end of June it did a 4-1 share consolidation so prices are at a multiple of 4x what they had been during its initial 42 months. Like the GLDX, it lost over 80% of its price since its 2Q 2011 high and with the fundamentals in place and sentiment turning suits those who prefer a diversified fund to individual companies. At this juncture it is a strong growth play. As of this writing, 3pm EDT July 22 it is +8.60% for the day.

Dividends Matter:

Some of the best values in the PM sector are dividend-paying companies. With prices crushed by the cyclical correction in gold and silver bullion and by market short-selling meant to mask inventory draw-downs in the face of surging demand, some significant producers are cutting costs and paying substantial dividends. With share prices still greatly depressed but rising and set for significant advance, several mid-tier and major companies appeal as value and dividend plays. I would set limit orders to catch these below their resurgent July 19 prices because the sector is volatile even in recovery. Review my archive and research for yourself to choose which companies you will select, how closely to the current price you wish to set buy orders and how quickly you wish to get on board.

IamGold (NYSE:IAG) is a mid-tier producer currently paying a 5.3% dividend. It has a low .17 debt/equity and 7:6 cash & equivalents / total debt. Revenues, at $1.57 billion are 2.5 x debt. IAG's cash flow is fine but the combination of the extremely negative sentiment on the sector and a steep decline in revenue growth has made it in my view one of the four biggest value (and income) buys in the PM sector. It was +8..96% July 22. Other great values are KGC, ABX and Silver Wheaton (NYSE:SLW) which is perhaps the safest investment in the sector and one of the market's top values. SLW's dividend is linked to income and is 2.24% currently. Having closed at $21.43 July 19 and with a consensus 12-month target of $38.25, it is as sure an investment as one can make. A streaming company, it pays about $4/oz. up-front for future silver production from the producers with which it contracts.

I have described the prospects and problems of major producer (c. 7.2 million gold oz. /year) ABX in many articles. I consider it a great value buy about which extreme and irrational negativity will dissipate in coming months, helped by the rise in gold and silver. ABX's immense revenues ($15 billion/year) and reserves enable it to sustain large debt ($14 billion, most of it long-term). Its debt/equity is .64. On another strong day, it is up 6.9% as I write. The cleanest balance sheet of the majors is Goldcorp (NYSE:GG) with $9 billion in revenue, $2.35 billion cash flow and .1 debt / equity: it yields 2.3%. Newmont Mining (NYSE:NEM) pays 4.9% with $2.94 cash flow and $9 billion in revenue.

For price appreciation and dividend, KGC yields 3.1% and a .22 debt to equity. It is a significant producer with revenues of $4.4 billion and at $5.10 is 57% below its October 2012 high. It is rated with a consensus price target of $8.50 which in my view does not allow for positive sector fundamentals and changing sentiment. It is +8.37% as I write.

For the best plays in gold and silver miners respectively, for clean balance sheets and powerful revenue growth, 24% and 16% respectively, I like EGO which pays 2.2% dividend and AG which is nearly debt free, has its best site, Del Toro just underway producing, half a dozen fine E & D properties queued up. In bad times for the sector, AG increased its silver and gold output 55% last quarter and doubled its production of lead and zinc. It has a consensus 12-month price target of $20/share.

Conclusion: Barring collapse of world economies, PM miners will surge. Even in a collapse they have not far to fall. That is, this sector offers bargain basement prices as Lawrence Roulston pointed out four months ago. The values have gotten better since then as the storm of short selling and related effects have played out. There is enormous upside to the GLDX and GDXJ ETFs and among the miners and streamer noted above. Other silver companies worth watching are Silver Standard Resources (NASDAQ:SSRI), Tahoe Resources (NYSE:TAHO), Pan American (NASDAQ:PAAS) and Fortuna Silver Mines (NYSE:FSM). You can acquire stakes in them via the SIL along with two dozen other companies like SLW (top weighting), AG, Coeur d'Alene (NYSE:CDE), Hecla (NYSE:HL) and McEwen Mining (NYSE:MUX), a debt-free junior growing output and revenues from its main sites in Mexico and Argentina.

The PM sector has been through a crash like the entire markets experienced in 2008 and is primed to repay investors able to initiate or add to positions.

Disclosure: I am long SLW, GG, MUX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I own precious metals companies among diversified holdings.