By Ivan Y.
For many years, Mexico has been considered a very friendly place to explore and mine precious metals and base metals. However, that may soon begin to change if the proposed 7.5% royalty is enacted. Under the terms of the proposal, which was presented to the Mexican legislature earlier this month, a 7.5% royalty would be applied to EBITDA income (earnings before interest, taxes, depreciation, and amortization) for all mining operations. An additional 0.5% royalty would be applied to income from gold, silver, and platinum, which would bring the total tax to 8%. Earlier in the year, a 5% royalty was proposed but now it has been raised to 7.5% minimum. The proposal is currently being studied and analyzed by the mining chamber.
So what does this mean if you are a gold/silver investor? Well that depends on whether you invest in the mining stocks or in the commodity. If you own a mining stock with a producing mine in Mexico, then obviously this royalty is bad news. However, if you invest in the precious metals ETFs like iShares Silver (SLV) or SPDR Gold (GLD), futures contracts, or bullion, then this new tax would actually be beneficial to your portfolio. A principle that gold and silver investors should remember is this: What's bad for the price of the metals is bad for the mining stocks, but what's bad for the mining stocks can be good for the price of the metals. That's because when bad things happen to mining companies such as higher taxes, higher energy costs, equipment failure, labor strikes, etc., production will be decreased. Consequently, that should help the prices of gold and silver due to lower supply.
Which mining stocks will be hurt the most?
The mining companies with the most to lose are the ones who are not diversified geographically, but instead have most or all of their operations in Mexico. Here is a list of 10 gold and silver producers that have a significant percentage of their production coming from Mexico. They are listed in order from most affected to least affected based on the percentage of their production that comes from Mexico. Please note that this is not meant to be a comprehensive list because there are literally dozens and dozens of publicly-traded mining companies with operations in Mexico.
1) SilverCrest (SVLC) only has one operating mine, Santa Elena, and it is in Mexico. This year, that mine is expected to produce about 33k oz. of gold and 675k oz. of silver. They also have two exploration projects, La Joya and Cruz De Mayo, and they are both in Mexico. All current and future production will thus come from the country. (Production from Mexico: 100%)
2) First Majestic (AG) is another miner whose production comes only from Mexico. They have five producing mines which all-together produced 2.8 million oz. of silver in Q2. All of their exploration projects are also in Mexico. (Production from Mexico: 100%)
3) Great Panther (GPL) is a primary silver producer with two operating mines in Mexico. The Topia and Guanajuato mines combined are expected to produce 2.4-2.5 million oz. of silver in FY2013. All of GPL's exploration projects are also in Mexico. (Production from Mexico: 100%)
4) Endeavour (EXK) is another Mexico-only producer. They have three operating mines in the country that produce gold and silver. They are expected to produce a combined 6 million oz. of silver and 68k oz. of gold this year. All their exploration projects, except for one, are also located in Mexico. (Production from Mexico: 100%)
5) Alamos Gold (AGI) has one operating mine, Mulatos, and that is in Mexico. This year Mulatos, which is a low-cost mine, is expected to produce 180k-200k oz. of gold. Although all of AGI's production currently comes from Mexico, that should change starting in 2015 when their two development projects in Turkey start producing. Those two projects should produce a combined 242k oz. of gold per year. About a month ago, AGI also completed the acquisition of the Esperanza gold project in Mexico. The Esperanza project could potentially produce over 100k oz. of gold once developed. (Production from Mexico: 100%)
6) Fortuna Silver (FSM) is a small gold and silver producer. One of its two operating mines is in Mexico. In Q2, the San Jose mine produced 580k oz. of silver and 4.7k oz. of gold. (Production from Mexico: 90% gold, 54% silver)
7) Pan American (PAAS) has three producing silver mines in Mexico: Alamo Dorado, La Colorada, and Dolores. They respectively produced 1.3 million, 1.2 million, and 0.8 million oz. of silver last quarter. PAAS produced a total of 6.2 million oz. last quarter from their global operations. In Q2, they had a large asset impairment write-down and one of the reasons the company cited was the potential effect of the proposed royalty in Mexico. So even though the royalty is not a law yet, earnings have already been affected. (Production from Mexico: 52%)
8) Coeur (CDE) is geographically diversified with operating mines in four countries. However, their most significant operation is the Palmarejo mine in Mexico. Palmarejo was the 6th largest primary silver mine in the world in 2012. Last quarter, the mine produced about 2 million oz. of silver and 28k oz. of gold. Overall, CDE produced 4.6 million oz. of silver and 61k oz. of gold last quarter. (Production from Mexico: 46% gold, 44% silver)
9) AuRico (AUQ) has two operating gold mines with one being in Mexico, El Chanate. In Q2, AUQ produced 48k oz. of gold with El Chanate providing 18.8k oz. of that amount. (Production from Mexico: 39%)
10) Goldcorp (GG) is the only one of the mega gold producers that has significant production coming from Mexico. They have three operating mines: Penasquito, Los Filos, and El Sauzal. In Q2, they combined to produce 191k oz. of gold and 5.2 million oz. of silver out of GG's total production of 646k and 7.2 million oz. of gold and silver, respectively. (Production from Mexico: 30% gold, 72% silver)
You may have noticed that most of the mining companies I listed were primary silver producers. That's because Mexico is the world's largest producer of silver but only the 11th largest producer of gold in the world. (Table is from The Silver Institute)
I continue to favor investments in the gold and silver ETFs over the mining stocks. If this proposed royalty becomes law, it will help the price of gold and silver because it will discourage mining companies from exploring and producing in Mexico, which will lower future supply.
I am not saying that the mining stocks mentioned above are bad investments. An 8% royalty is not the end of the world, but it will definitely have a negative impact on earnings and stock prices if it becomes law.
Additional disclosure: I am net long gold and silver ETFs.