Investing In Gold & Silver Mining Stocks: How To Beat The GDXJ

| About: Americas Silver (USAPF)

Summary

A overview of my strategy on how to beat the GDXJ.

Proof of how to beat it.

A example of a stock that will out perform the GDXJ.

Back in January, I posted an article on Seeking Alpha titled The 20 Best Risk/Reward High Return Gold & Silver Mining Stocks. Over the last three months, those 20 stocks have had an average return of 128%. That is significantly better than the baseline that I compete against, which is the GDXJ miners ETF. The GDXJ returned 70% during this period. Here are the numbers:

Stock Symbol US Price (1/3/2016) Shares (1/3/2016) FD Mkt Cap (1/3/2016) US Price (4/22/2016) 3 Month Return
Alexco Resource Corp. AXU $0.34 78M $26.52M $1.11 226%
Almaden Minerals AAU $0.69 94M $64.86M $1.15 67%
Argonaut Gold OTCPK:ARNGF $0.86 159M $136.58M $1.86 116%
Barkerville Gold Mines OTCPK:BGMZF $0.19 242M $45.42M $0.44 132%
Bear Creek Mining Corp. OTCPK:BCEKF $0.42 101M $42.29M $1.93 360%
Brazil Resources OTCQX:BRIZF $0.33 104M $33.78M $0.89 170%
Coeur Mining CDE $2.48 138M $342.24M $6.89 178%
Endeavour Silver Corp EXK $1.42 108M $153.36M $3.78 166%
First Majestic Silver Corp AG $3.27 166M $542.82M $8.90 172%
Hummingbird Resources OTCPK:HUMRF $0.19 91M $16.82M $0.40 111%
Integra Gold Corp OTCQX:ICGQF $0.25 415M $101.86M $0.48 92%
McEwen Mining MUX $1.06 305M $323.30M $2.34 121%
Midas Gold Corp OTCQX:MDRPF $0.22 195M $43.64M $0.53 141%
Orezone Gold Corp OTCPK:ORZCF $0.19 126M $24.10M $0.52 174%
Pan American Silver PAAS $6.50 153M $994.00M $13.83 113%
Perseus Mining Ltd OTCPK:PMNXF $0.25 533M $134.66M $0.39 56%
Sabina Gold & Silver Corp OTCPK:SGSVF $0.53 215M $113.30M $1.60 202%
Silver Lake Resources OTCPK:SVLKF $0.13 505M $66.38M $0.27 108%
Silver Standard Resources SSRI $5.18 84M $435.12M $8.35 61%
Truegold Mining RVRVF $0.17 424M $71.93M $0.52 206%
Totals $24.67 $56.18 128%
Gold Miners ETF GDXJ $19.84 $33.63 70%
Click to enlarge

My worst pick was up 56% and my best 360%. Not bad. These high returns were obtained by focusing on quality projects that I deemed to be highly undervalued with excellent risk/reward characteristics. I also had access to my database, which includes 575 gold and silver mining companies that trade in New York, Toronto, Sydney, and London. I analyze all of them, and my focus is to beat the GDXJ and to return at least 500%.

As the numbers above show, this can be done. And this list does not include the extreme high return stocks. Many extreme high return stocks have literally blasted off from their lows. Silver Bear Resources went from a share price of 1 cent in January to 16 cents today. There are dozens of stocks that have 10+ bagger potential at higher gold and silver prices. The difference between these extreme high return stocks and the list above is risk. It's okay to stick with quality stocks (like the one I'm going to talk about today), but the big returns will require additional risk.

The Junior mining sector is appealing from a risk/reward viewpoint. Whereas the risk is substantial for Junior gold and silver mining stocks, the upside is also substantial. My current focus is on both undervalued producers and companies with solid projects that are advancing toward production. As undervalued producers become harder to find, I will turn my attention to development companies because these are companies that will be rewarded with large cash flow at higher gold prices.

I consider all Junior development companies as high risk speculation stocks, because you can never know if they will make it into production. If they have trouble with financing, or if the geology is analyzed incorrectly (e.g. Rubicon Minerals), or if any number of issues arises, these stocks can drop like a rock. Also, management is crucial and can disappoint investors with poor decisions and bad execution. Lastly, quality projects tend to get taken out by larger companies which generally do not have the upside potential that I am looking for.

I think now is a good time to look for undervalued companies with growth potential. If we are in another gold bull run that could see new highs above the 2011 level of $1935 (see historical prices), then it would be wise to spot the potential winners. The biggest winners are likely to be those that are currently valued under $150 million, and are sitting on development projects that have all of the factors needed to be successful. I will go over these factors below for one such Junior that should easily beat GDXJ.

My investing style is to focus on potential future cash flow in conjunction with higher gold prices. For instance, what is the future value of MyFavoriteGoldStock if they develop a 5 million oz project and produce 300,000 oz annually at $2,000 gold? If you just do a quick and dirty analysis using potential future cash flow, you get 300,000 oz x $500 (estimated cash flow per oz) = $150 million in annual cash flow. If you multiply that by 10 you get a $1.5 billion valuation. Note that some companies were valued at 30x cash flow during the last mania in stocks in 1980, and a 10x cash flow valuation is quite common today for strong mining companies. A conservative method is to use 5x cash flow.

It's amazing how valuable a mining company could become that owns large profitable projects. There are many development stocks today with solid projects. Not all of them will be successful in building their mines, so it is a crapshoot picking the winners early. The smart play is to watch these stocks and see who is going to get financing. Of course, the longer you wait the higher will be your entry price.

The most ideal stock is an undervalued company that is either financed to build their first project, or they are a producer with growth prospects. The only way you can understand the risk of an undervalued stock is to do your own due diligence. Below I will go step-by-step and show you what to look for when analyzing a mining stock. But even with this data in hand, you should do your own due diligence to confirm what I have written.

Even if you think you know a stock intimately, the data will change. If there is one constant in the story of a stock, it is change. And the higher the risk, it seems like the data changes more frequently. Whereas a Major or a strong mid-tier producer can weather a data change, a Junior can drop in value a significant percentage on small changes. The volatility can be staggering, and sometimes Juniors do not survive these changes.

The two most important rules to follow to limit your risk exposure is to 1) Only invest in company that has the goods. In other words, do not chase drill results. Make sure that your company has at lease one very good project. 2) Do not invest more than 1% of your portfolio into a high risk stock. Thus, if your total invested dollars is $100,000, then your max is $1,000 for a high risk stock. This may seem too low, but you have to stay humble and acknowledge the high risk. If you think the stock is low risk, then you can double this total to a maximum of $2,000. You may be thinking that you could end up 80 stocks. Perhaps, but this won't happen if you buy bullion and/or ETFs as a foundation. With bullion and ETFs you can go over the $2,000 limit.

The following analysis is based on data from the www.goldsilverdata.com database.

Stock Name

Symbol (US)

Type

Risk

Share Price (US)

FD Shares

FD Mkt Cap (4/22/2016)

Americas Silver Corp.

OTCQX:USAPF

Silver

Moderate

0.25

423M

$101M

Click to enlarge

Americas Silver Corp.

Americas Silver Corp (formerly Scorpio Mining) is a mid-tier silver producer in Mexico and Idaho. They merged with U.S. Silver & Gold in 2014, who had the 54 million oz Galena high grade silver mine. This is an undervalued stock with a FD market cap of $101 million. The reason it is highly undervalued is because their costs were high in 2013 and 2014 and they were losing money. They have now reduced their costs by 66% (see company video) and are now profitable at $15 silver. I think they can keep their costs down and produce 4 or 5 million oz per year of silver equivalent. They will never be a low cost producer, but that makes them highly leveraged for higher silver prices. Although, it also makes them a high risk investment if silver prices go back down below $15.

They have about $5 million in cash and $7 million in debt, which isn't a bad balance sheet. They recently reorganized their debt and it is not due until 2017. If you are confident silver prices are heading higher, this is a good speculation stock. They could become a billion dollar company at much higher silver prices.

I think the combination of U.S. Silver & Gold and Scorpio Mining was a good fit that is going to payoff. It is currently under the radar, but that won't last long if silver prices keep rising. With their resources and growth potential this stock should do extremely well over the long term. I really like the CEO who has done an excellent job lowering their costs and making them profitable.
This next paragraph was written for Scorpio Mining before the merger with U.S. Silver & Gold, which became Americas Silver Corp. I think it is insightful:

I like their plans. They are expanding production at their underground Nuestra Senora underground mine. They are building their El Cajon underground mine for production in 2015 (currently on care and maintenance). And they are planning to build their San Rafael open pit mine for production in 2016 or 2017. My only concern is can they increase their resources from 50 million oz to 80 million oz to extend their mine life? They have plenty of targets on their 65,000 acre Cosala property. If silver prices rise, they are leveraged to take advantage of that windfall. And if they are successful with exploration, they can increase the life of their mines and increase production.

The 3 Ps

Properties

  • Do they have a flagship project? Yes, long life mine.

  • Do they have a pipeline of projects for growth? Yes, additional mines are possible from current projects.

  • Do they exploration potential to expand resources? Yes, plenty of drill targets on a large property.

  • Is the grade and recovery rate satisfactory? Yes, high grade mines.

  • Is the location satisfactory? Yes, Idaho and Mexico are good places to mine. They have no infrastructure issues.

  • Do they own it? Yes, 100%.

People

  • Is it an exploration or production team? Both.

  • Do they have experience? Yes, it is a highly experienced team.

  • Do they have a track record for building mines? Yes.

  • Are they investor friendly and not always diluting? Currently high share dilution, but they are focusing on free-cash flow and paying off their debt.

  • Is the team large enough to build a mine? N/A.

  • Have you listened to a CEO interview? Yes, he is very impressive. He talks about the important issues and is comprehensive.

  • Are they cash focused? This is unknown until they make some money.

  • How much stock does management own? Unknown.

  • Does the website and company presentation provide adequate guidance and details? Yes.

Projects

  • What are the resources? 105 million oz at 120 gpt. This total is likely to grow.

  • What documentation has been released (PEA, Pre-feasibility Study, Feasibility Study)? N/A.

  • What is the capex? N/A.

  • What is the after-tax IRR? N/A.

  • What are the estimated cash costs and all-in costs per oz? About $14 all-in (free cash flow).

  • Can it be financed? N/A.

  • How will it be financed (debt, equity, streaming)? N/A.

Share Structure

Is it highly diluted? Yes, 423 million fully diluted shares.

Timeline Risk

N/A.

Market Cap Size

Is it too big or too small? No, at $101 million it is still cheap for their resources.

Stock Chart

Is this a good entry point? Perhaps not ideal. It has made a big run in the last two months. Perhaps its better to wait for a pull back.

Balance Sheet

What is their cash/debt situation? $5 million in cash and $7 million in long-term debt.

Valuation

  • What is their future market cap growth rate at $100 silver? 1,000% at 4 million oz. (see below).

  • What is their future free cash flow at $100 silver? $200 million annually at 4 million oz. (4,000,000 x $50).

  • What are their future reserves valued at today? $1.27 per oz at 80 million oz. ($101 million / 80 million oz).

Future market cap growth:

  • Current Market Cap: $101 Million.

  • Future Market Cap: 4,000,000 oz x $50 oz = $200 million annual cash flow x 5 = $1 billion

  • Compare the two values and you get 1000% increase.

Is Americas Silver Corp highly undervalued? Yes, with a potential increase of 1000% and future reserved valued at $1.27, it is highly undervalued.

You can check the data included in this article at Americas Silver Corp's website and my own.

Disclosure: I am/we are long USAPF.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.