As most of us know by now, a third round of quantitative easing from the Federal Reserve is likely in the cards. A great way to position your portfolio ahead of central bank action is with gold and silver, either in physical form as I have previously recommended or in the form of an ETF that tracks the price of these precious metals such as (SLV), (GLD) or (IAU). In the last month, these ETFs have gains of 13.4%, 5.52% and 5.50%, respectively. The gold and silver companies tracked by the ETFs (GDX) and (SIL) have outperformed the aforementioned ETFs in the last month with returns of 16.75% and 23.76%, respectively. For those investors seeking possible returns in the precious metals sector that outperforms the returns from owning physical metals or the GDX and the SIL, I have recommended picking up an individual gold mining company or one of the silver companies.
For those investors who want to play the individual companies, I am now suggesting that it is best to own both a company that primarily is gold oriented and another that is primarily silver oriented. In this article, I wish to highlight one gold company and one silver company that I believe are good buys at current levels ahead of possible QE3 and for the long term. I think owning both of the following companies together provides a strong risk reward ratio in the years ahead.
Silver Wheaton (SLW): SLW is one of the best run companies in the mining and metals sector and represents one of the best possible bets on silver an investor can make. While I have previously recommended (and still recommend) Pan American Silver (PAAS) and Silvercorp Metals (SVM) as excellent plays on silver, I believe that SLW has a superior business model. SLW operates as a worldwide silver streaming company. Silver streaming is basically a process by which the company purchases a mining firm's silver production in order to distribute that silver in the market. SLW has contracts to purchase silver in bulk at prices well below market value and then proceeds to sell the silver at higher prices. The company has "14 long-term silver purchase agreements and two long-term precious metal purchase agreements whereby it acquires silver and gold production from companies located in Mexico, the United States, Greece, Sweden, Peru, Chile, Argentina, and Portugal."
According to the company, "the predetermined price that SLW pays for future silver production is approximately $4.00 per ounce, with a small inflationary adjustment, ensuring that costs are fixed." At such low fixed costs, this allows SLW to stabilize operating costs and reduce downside risk, while providing leverage to the price of silver. Besides the initial payments to secure the rights to the silver, no additional capital expenditures or exploration costs are required. At the same time, SLW benefits from the production and exploration growth of its operating partners. This low-risk business model creates long-term shareholder value. Central to creating shareholder value are multi-year agreements to purchase at low fixed costs all or a portion of the silver production from mines in Mexico, Chile, Argentina, Peru, Sweden, Greece, Portugal, Canada and the United States. In addition, a large percentage of the company's revenue is derived from low cost and long life mining operations.
SLW currently trades at $34.15 and has a 52-week trading range of $22.94-$42.50. On average, about 4.2 million shares exchange hands daily. The company trades at a 21 multiple but only a 0.84 PEG ratio and currently yields 1.1%. This company is and will continue to be a winner. It is by far my personal favorite in the space and I believe it could not only outperform SLV but also my other recommended silver companies SVM and PAAS.
Barrick Gold (ABX): My top choice in the gold space that I think pairs best with SLW is ABX. ABX is the strongest gold company in the world in my opinion. At the end of 2011, ABX's proven and probable gold reserves were 140 million. It also had 1.07 billion ounces of silver contained within gold reserves and 12.7 billion pounds of copper. In 2011, ABX produced 7.7 million ounces of gold at total cash costs of $460 per ounce and produced 451 million pounds of copper at total cash costs of $1.75 per pound. For the current year, ABX now expects gold production of 7.3-7.8 million ounces at total cash costs of $550-$575 per ounce. The company also expects 2012 copper production of 460-500 million pounds at cash costs of $2.10-$2.30 per pound. ABX's annual gold and copper production base is expected to be over 8 million ounces by 2015 and over 600 million pounds by 2013.
The company is strong but the stock is down 16% this year along with most of the miners tracked by the GDX ETF, which is also down 7.5%. Some of ABX's decline came after a moderately weak Q2 earnings report that highlighted some cost issues with the Pascua-Lama project. The project at Pascua-Lama is expected to produce less gold than initially anticipated and ABX now expects that it will cost a lot more than previously estimated. Pascua-Lama contains estimated gold reserves of 18 million ounces and ABX hopes to produce between 800,000 and 850,000 ounces of gold a year at this site when the mine is at full operation. While exact mining costs at Pascua-Lama are currently unknown, they are expected to be high, as discussed on the latest conference call. On that call, ABX discussed cutting future costs as evidenced by its recent decision with respect to the Donlin Gold Project in Alaska. This project was a joint venture in which ABX partnered with NovaGold (NG), a 50% owner of the gold deposit location at Donlin. The news of canceling the deal with NG at Donlin, coupled with the lackluster earnings and gold production costs, hurt the stock as it fell about 8% on the news.
There are some new projects coming on line for ABX including the joint project with Goldcorp (GG) at Pueblo Viejo. The company expects to produce from Pueblo Viejo nearly 100,000 ounces of gold in 2012 and approximately 650,000 ounces of gold in 2013. There is also the Turquoise Ridge mine in Nevada where ABX owns 75% and is in charge of daily operations at the facility. Newmont Mining (NEM) is a partner on this project as well. The gold reserves at Turquoise Ridge are estimated at 5.3 million ounces.
Management has been doing some large buying as well, with the new CEO Jamie Sokalsky having bought 50K shares on August 3 at $32.59 each and a director recently bought 100,000 shares. Turning to the balance sheet, they have a flat to increasing debt to asset ratio with a large amount of cash on hand. As of June 2012, the company has $2.3 billion in cash and equivalents with $13.9 billion long-term debt and roughly $51 billion in total assets. With this cash, they have a large $500 million exploratory budget and recently approved an increase to the dividend of 33%, raising it to 20 cents paid quarterly effective May 2012. I expect to see increased dividends if the company can thrive.
While I like all the gold miners right now I believe ABX is superior to its largest rivals GG and NEM. The company is cheap on a P/E basis of only 8.9 and a PEG ratio of 0.1. The company trades at $37.80 a share right now on average volume of 8.5 million shares. It has a 52-week trading range of $31.00-$51.95.
Bottom line: I believe both gold and silver companies will outperform the precious metals they deal in. Should QE3 become reality I expect to see and immediate response from these companies. Should it not be announced I still believe the long term thesis holds as other central banks are considering their own stimulus measures and inflation is all but guaranteed in the future. I think it is more than likely that silver could outperform gold in the next 12 months and I believe the individual companies may outperform the metals. Should you choose not to invest in physical bullion or an ETF such as GLD, IAU or SLV that tracks the price of the metals, then I highly recommend pairing both a silver and gold company together in your portfolio.