Flush them down the toilet? No, it's not that simple although many of us may be feeling that way. The answer to the title is that it depends on when you entered this despised sector, how much of your nut you have allocated to it, what your time horizon is and how adequate income is to satisfy life's basics. If you don't have an urgent need for cash soon, don't do more than trim now, even if you are holding some turkeys like Vista Gold (VGZ). The only other exception would be if you entered since mid-April, are not far underwater and simply want out of the sector. That's understandable though it is filled with value plays.
The investment or divestment choices suggested below depend on the above factors in tandem with short-term and long-term outlook for precious metals [PM] and miners, the PM sector as I call it. Action year-to-date, especially in 2Q and again the past several trading days indicates some guidelines for proceeding.
First, it is possible that dropping prices, like so many events in the markets, reflect perceptions and expectations about Fed fiscal policy. After a few weeks of hibernation, taper talk returned August 6, as Charles Evans, head of the Chicago Fed said "there has been good improvement" in the labor market so there can be some tapering.
That comment about labor is what my parents would call a fib (look at the jobs charts of American Business Analytics) but that doesn't lessen the impact of comments by Federal Reserve regional Presidents. Richard Fisher, President of the Dallas Fed seconded the view of Evans, saying that September would see some tapering of the Fed's purchase of T-Bills. The mainstream narrative, as in the Bloomberg piece linked in the previous paragraph is that taper talk has knocked gold prices down again. "Financial markets have become too accustomed" to Fed purchases of debt, Fisher said, "to keep the markets levitating indefinitely." So will they taper? Maybe.
It sounds like change is in the winds, but there are 12 regional Fed heads plus the seven members of the Central Board so the markets continue to suffer from conjecture and an overload of interpretations of the consensus, if any, at the Federal Reserve.
People buy PM bullion not only or not mainly because QE debases the USD but because they worry about imbalances in the economy, government giantism and intrusiveness and about the future of America generally. In an era in which it is difficult to miss the signs of pervasive socio-economic decay, accelerating for nearly 50 years, many people want portable wealth as well as a symbol of enduring value. Other investors have been buying the PM sector since mid-April because it is the prime and of deep value in a sea of inflated asset prices. All this is true, but its still leaves investors in the sector with the challenge of how to arrange their holdings with signs that yet another in a seemingly endless series of price drops has arrived.
Debt levels are a key theme in the troubles of PM miners as bullion prices drop. With the exception of market behemoths like GE whose immense cash flow can support large liabilities, debt drags down share price. With a few exceptions, PM miners are not large caps (even the largest are far from giant or mega caps) so levels of debt become increasingly important in deciding what to trim, jettison or hold. Here are some companies with good sites, very low debt/equity and good revenue growth.
In the mid-tier space there are several producers with good to outstanding quick ratios and very low debt/equity ratios that do not correlate with recent price action. Silver Standard Resources (SSRI) has 3x cash and equivalents to debt and an outstanding 8.3 quick ratio. Its 27.7% revenue growth is very enticing and its $111 million cash flow is high to its $250 million revenues, modest but respectable for a company just getting into production while keeping costs and debt at very low levels. It closed August 6 at $6.56 just 17% above its 2Q and 52-week bottom. Firms target it for $10.80, 41% above its close.
New Gold (NGD) has a 4.3 quick ratio and cash and equivalents 3:4 total debt. Its revenue growth is a powerful 19.6% and its $339 million cash flow is 42% of $820 million revenues. Having closed at $6.26 Tuesday, just 10% above its 2Q and 52-week low, NGD also looks like a strong buy and is so rated by five major firms.
Eldorado Gold (EGO) and First Majestic Silver (AG) have good quick ratios (cash, cash equivalents, receivables and securities divided by liabilities) of 3.8 and 2.2 respectively. AG's C&E (cash and equivalents) is 6:1 its total debt and it has seven producing sites and six development projects in Mexico waiting a rise in bullion prices. Both EGO and AG are restraining costs and growing production steadily. AG is highly profitable with its $89 million net income more than one-third of its revenues while EGO is nearly as good with its $191 million net income about 1:6 its $1.21 billion revenues. It pays a twice yearly dividend that yields 1.9% on a high 49% payout ratio. In its 2Q results conference call, EGO execs did not indicate a cut back of the dividend, though Kinross Gold (KGC) with nearly 4x EGO's revenues and a good quick ratio of 2 recently announced it would suspend its September dividend as part of cost-cutting. KGC is a value though not as strong as EGO given its slow 2.2% revenue growth and falling net income.
Although not mentioned as often as its silver space peer, Silver Wheaton (SLW), Franco Nevada (FNV) a gold, silver and energy royalty and streaming company whose $91 million net income is 22% its $430 million revenues. It is debt free with $830 C & E on hand. It has been strongest in the entire PM space in recovering off the 2Q low. It has target estimates of $46.80, 21% above current price but less upside foreseen than most issues in the sector. SLW has a miserable .1 quick ratio but because of its streaming model (tiny overhead and staff) remains one of the most profitable companies in the markets with net income nearly 70% of revenues. Despite daunting sector headwinds, it is growing revenues at 3.1% and closed Tuesday 40% below its consensus target estimate of $33.25. It is rated Strong Buy by a wide consensus of 16 analysts from major firms.
With a price/sales of 2.41 and P/B just .47 and given the above numbers, SSRI looks like a premier value with NGD, SLW, AG and EGO also among the top tier of buys for those who have cash to invest and don't wish to enter or add to sectors already near the top of a QE-inflated range. In the small cap space, Fortuna Silver (FSM) with a great quick ratio of 4.5 and debt free with $49 million cash flow on $160 million revenues is the choice in silver while McEwen Mining (MUX) with a 3.2 quick ratio, no debt and increasing production at its El Gallo sites in Sinaloa, Mexico and at San Jose in Argentina, is the best small-cap gold producer. In its back pocket is a rich copper site at Los Azules which it will sell when prices recover in that commodity. With no debt and slowly expanding low cost production in Mexico, MUX can afford to wait for a better price.
Patience is the Rx for those invested in the three majors, Barrick Gold (ABX), Newmont (NEM) and Goldcorp (GG). ABX recently realized $500 million on its sale of Canadian Barrick Energy and cut its huge 4.8% dividend 75% as part of its effort to regain profitability while waiting for prices to rise and production at its Pueblo Viejo site in the Dominican Republic (deal settled there in May) to ramp up to speed. In the mid-term, it strives to achieve remediation of tailings and drainage at its immense, low-cost, high-altitude Pascua Lama site on the border of northern Chile and Argentina. ABX, NEM and GG have revenues of $15 billion, $9 and $4.9 billion respectively but only ABX is growing revenues, albeit modestly in this period of depressed bullion prices and cost cutting. I wrote recently on its prospects.
It is never good to lock in a loss when chances for future growth are significant and they remain so in the PM sector. The fundamentals of supply and demand remain very strong and the shakiness of the fiat currencies and proliferation of ex-USD bilateral trade portends change in the reserve system in which gold likely will enhance its role.
If you can buy: the five best mid-tier companies and two small caps are described above. For those who can afford a 2-4 year time frame before substantial improvement, ABX is compelling as the fund managers of Goodhaven recently argued, noting its "huge and low-cost reserves." NEM has a decent quick ratio, 1.3, superior to GG's 1. NEM's $503 million cash flow, while half that of ABX is 3x that of GG and is a higher proportion of revenues. NEM yields 3.5%, GG 2.2% and for now are maintaining payout. In my view, the best short- to mid-term buys are in the mid-cap space, as noted above.
The jokers in this deck are two: the possibility of further decline of already challenged global economies resulting in general risk-off trades with PM miners as usual being the first to get ditched. Secondly, if the Fed indeed begins to taper as we approach 4Q 2013 or increases its "hawkish" taper talk, the markets will suffer and PMs will get the double whammy of risk-off trades and the perception that their value lies solely or mainly in the expectation of increasing Sovereign debt and devalued currencies.
QE supports deficit spending by Sovereigns so I do not see it being curtailed. However, investors in the PM space, indeed in all asset classes need to be mindful that it could occur. We have the precedent of May 22-June 28 at hand. The PMs are much closer to a bottom (although its precise depth still may be tested, as I wrote here) before a sustained recovery. With that in mind, the best values are the mid-tier issues noted above and Freeport McMoRan (FCX) that bucked the August 6 sell-down, rising .48% and still 36% below consensus 12-month target. Also note that FCX's top executives James Moffett and Jim Flores in the past two months bought nearly $21 million and $49 million respectively in FCX shares.
Do not sell out your PM stocks. If your resources or patience are utterly exhausted, trim your holdings because of the problematic scenarios noted in the previous paragraph. Otherwise, hold or buy as indicated above.
Additional disclosure: I own precious metals companies in various funds.