Are some mining firms bargains or are they cheap for a reason? Many base metal and precious metal miners are trading at attractive valuation multiples, which justify a comparative analysis of these two very different commodity families.
A Tale of Two Commodity Markets
Gold holdings rose by 2.4% so far this year, as assets increased to 2,412.42 tons, continuing the trend of steady growth that began in 2004. Gold has been in high demand for the past 11 years as currencies have fluctuated and nations attempted to stimulate their economies.
Today, strong demand is seen specifically through the increase in the vaults of exchange-traded securities such as the iShares Silver Trust ETF (SLV) and the SPDR Gold Trust ETF (GLD). Exchange-traded product holdings have increased by 0.5%, even as spot prices have dropped 4.3%.
There are many reasons to think that the demand for precious metals will be robust in the future, and that the 11-year trend of gold stockpiling as a portfolio holding will continue. It is projected that gold values will increase in the next six months as national banks, especially in China, the United States, and Europe seek to supplement their reserves. Essentially, every central bank seeking some vestige of legitimacy is a potential buyer of precious metals.
That being said, robust future demand does not ameliorate today's challenges for precious metal miners. The rise of commodity-backed ETFs such as the GLD and SLV is bullish for Argentina's Silver Standard Resources (SSRI), yet it has not soothed investors who still trade the stock cheaply. Investors fear Argentina's appropriation of YPF Sociedad Anonima (YPF) assets and the country's high inflation.
While Silver Standard maintains that it has had no political clashes with the government in the six years it have been in operation and finds little reason why the government would benefit from taking over company assets, Silver Standard is regulated by an administration that controversially renationalized YPF in order to meet the country's energy needs. Having one of the largest silver mines in the world at its disposal, China's seeming insatiability for silver, and the projection that silver prices will rally during the second half of the year are very encouraging factors for this company.
China's high demand for silver has created margin pressure for BHP Billiton (BHP) and Rio Tinto (RIO), however. Moreover, this unhedged company sold shares at $11.41, a price nearing Silver Standard's 52-week low. Due to its higher productivity and the current discounted price of silver in the markets, Silver Standard is promoting itself as a growth stock.
On the other hand, the market for base metals looks terrible. Demand is derived largely from fixed-investment in China. If this property bubble stalls the demand for iron ore and other base metals could plummet.
Though this might seem like cause for caution, many miners are expanding production capacity. Iron ore companies in Australia are turning brokers' heads as they look for recommendations that add risk to their investors' portfolios.
Although Rio Tinto and BHP Billiton have declined 2.2% and 5.7%, respectively, since peaking last year, they have stayed fairly steady this year, boast a solid operating margin for big low-cost producers, and are the top three producers of iron ore in the world. Of the two, Rio outperformed BPH earlier this year and has had success in focusing on producing iron ore even though Rio is a diversified company. Yet BPH has in its favor a larger size and scale and more product diversity.
Mining for Value
Despite a rosier outlook for precious metals, there is considerable overlap between miners of different metals:
Silver Standard Resources
On a price-to-earnings basis gold miner stocks like Randgold Resources and Newmont Mining are more expensive than their silver mining or base metal mining counterparts. The silver miners Silver Wheaton and Silver Standards Resources are cheaper than these dearly-priced gold firms, but are comparably priced to RIO. The PE ratios of BPH and Vale are thankfully more attractive than RIO, silver miners, and gold miners.
The price-to-sales ratio is even more confusing. Silver Wheaton, Randgold Resources, and Silver Standard Resources are expensive by the price-to-sales metric.
Fortunately, the price-to-book ratio reveals a few miners that are cheap relative to the accounting values of their net assets. Kinross Gold and Silver Standard Resources trade below their book values. Vale trades near its book value. Low PB ratios are great signals for value investors, but bear in mind that the inverse is not as useful: high price-to-book values may be justified based on when the assets were purchased, and at what price. Conservatism is a cornerstone of modern accounting, and accountants are unable to "write-up" the assets of a firm even as the value of mineral reserves sky-rocket.
Holistically, Kinross Gold and Vale are attractively priced. They both trade at attractively low price-to-book values and they have low price-to-sales ratios. Kinross is more speculative in the sense that it is not generating positive earnings. However, of the two companies, Kinross is the more interesting one, since it is arguably cheaper, yet is a precious metal miner, rather than a base metal miner exposed to the Chinese construction bubble. Investors should consider these two companies as potential mining investments.
Given today's macroeconomic outlook, investors should consider mixing metals rather than being lured to base metal miners by their low price-to-earnings ratios. This caution will avoid excessive exposure to a "hard-landing" in China.