Precious Metal Miners: Value Buy Or Money Pit?

by: Emmet Kodesh

The answer to the questions posed in the title is "both." The short-selling by strong hands that began not later than February 28, 2012 and intensified on April 10 this year have created numerous buying opportunities, shifted gold and silver to Asia and created a potential money trap for retail investors who fail to trim gains or overplay the sector.

Those who bought the thesis and PM (precious metal) mining shares or PM bullion ETPs like Sprott Silver (NYSEARCA:PSLV), Swiss Gold Trust (NYSEARCA:SGOL) or Central Fund of Canada (NYSEMKT:CEF) early in 2012, or in the May to July 23, 2012 basing period, or in the great rise of August - October of that year and held are deeply underwater. Only those who bought in the numerous troughs that have occurred since mid-April (when the indices also tanked) may be green and that depends, for example, on whether they bought June 7 or June 22-30. If you enter this volatile sector, you become a player even if you take the approach of an investor. Despite strong fundamentals for gold and very strong basics for silver, this sector is a roller coaster as PM price action since September 18 exemplifies.

Anything that happens to bullion prices is magnified in PM miners as underscored October 31. Gold (NYSEARCA:GLD) dropped 1.5% and first rate gold miners like mid-tier Eldorado (NYSE:EGO) and debt-free, revenue-growing junior McEwen (NYSE:MUX) plunged 4.80% and 7.14% respectively.

The myriad tech-industrial applications of silver should shield it from such dramatics but those familiar with the sector know that it is jumpier than gold. Silver (NYSEARCA:SLV) fell 3.5% October 30 but top of the line mid-tier silver miners First Majestic (NYSE:AG) and Endeavour (NYSE:EXK) fell 5.98% and 7.56% respectively despite their stellar YTD and 3Q results in the field, growing production 50% - 105% while lowering costs. The base metal production of AG in lead and zinc rose 158% and 164% and 38% in silver equivalent oz. but no matter. Top shelf debt-free junior silver miner Fortuna (NYSE:FSM) which had held up well during the first three days of this week's mostly downward volatility surrendered to the trend and fell 5.07%. Premier silver streamer Silver Wheaton (NYSE:SLW) flopped 7.01% on heavy volume. In part this reflected concerns that it might be hurt by Barrick Gold (NYSE:ABX) saying it might offer shares in or consider selling (unlikely) its world class mine at PL (Pascua Lama) straddling the border of northern Chile and Argentina. I have reported several times that SLW's stream from the PL's production can be satisfied by ABX's mines at Lagunas Norte in Peru and Veladero in Argentina. This fact, however, despite being emphasized by SLW CEO Randy Smallwood does not inform sentiment. As I have noted before, when the markets hit turbulence, negative sentiment makes PM issues the first ballast cast overboard.

Barrick's announcement that it would offer $3+ billion in 2 - 10 year notes should have generated confidence in its plans to go forward, especially in the context of its reduced capex. It certainly can service the lines with its $14 billion revenues. But it shared in the sector's general contagion, down 5.37% October 31.

Whether or not PM miners are wealth destroyers depends on when you entered or plan to enter, and trim. Most issues are nearing territory in which they are strong value buys with less downside (one cannot safely say "little" downside) and great upside potential. Price history and intrinsic merits suggests that EXK below $4.20 (or, for added safety, below $4), AG below $11, FSM below $3.60 and MUX below $2 are very strong buys. However, the sector is vulnerable to artificial action and you must be willing to trim gains at levels well below the merits of the company and the strong fundamentals for the commodity to avoid going red for an extended period… or face the unpleasant prospect of selling at a loss.

Deutsche Bank and TD Securities among others would say that ABX below $22 is a strong buy, below $20 even stronger: from my experience and for those with limited means or less taste for an enticing play, below $18 has the potential of a 4-bagger if you can wait a year: a ten-bagger if you can wait two. ABX still has the largest reserves and the lowest costs of the major and mid-tier producers. SLW below $23 is a good buy (17 major firms have its target estimate at $33.50): for an extra margin of error you could wait to see if it approaches $20. It has not been in that area since coming off its June 26 secular low at $17.75. An exception to the weakness and volatility is Tahoe Resources (NYSE:TAHO) that has outperformed the sector as it nears production at its world class site of Escobal in Guatemala. Since I wrote a focus piece on it July 25, it has risen 32%. The train soon may leave the station on TAHO.

At current valuations, there are compelling reasons to consider the better PM miners value buys. However, to avoid them becoming a money trap for extended period, you must trim gains periodically. Given action in the sector, even the best companies should be pruned greatly when substantially positive. Many people play even the most solid companies, CBS (NYSE:CBS), Starbucks (NASDAQ:SBUX), Boeing (NYSE:BA), Amgen (NASDAQ:AMGN) and Disney (NYSE:DIS) in other sectors for gains. The markets have raced up from the intraday 1646 S&P October 9 low while new housing sales fell 5.6% and the Health Insurance Mandate wreaks chaos in the economy, lives and political culture.

At current prices and keeping in mind the levels indicated above, those not surfeited in PMs or willing to play the sector for gains (in non-taxable accounts) are near solid buying territory. While the mid-to-long term outlook for our socio-economic system is grim, indeed if you look at larger cultural trends it is very dark, there is hay to be made in the short term. At present, the major indices are overbought and running on QE, momentum and "hopium" that seeks compensation in growth for crushed bond yields. While PM prices are low, nothing about our culture suggests that artificial action in this and other sectors will cease. Such action perhaps is greatest in PMs because they reflect genuine values that are not meant to survive an era that sells illusion and attitude, spins narratives and displaces justice with color of law.

One needs to be in the indices but to restrain buying until a likely pull back from the most recent run of this mechanical bull. Expect a November correction and then a shaky rise toward the New Year. In the mid-to-long term, most equities have the potential to become money pits and wealth destroyers. Thus I sought to identify and examine the core survivors here. It is with these perspectives that the opportunity for limited buying and then trimming of PMs is made.

Disclosure: I am long ABX, FSM, MUX, SLW. 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.