Gold And Silver For Rough Weather: Buying Time

by: Emmet Kodesh

"It is tragic to witness the West near the edge of a cliff as central planners recklessly endanger the entire global financial system and ensure that the West will eventually collapse." - Dr. Keith Barron, 8-22-13

This is another in a series of articles on sectors and specific companies with which to ride out an extended period of turbulence in markets, economies and polities. The surge of the PM (precious metals) sector the past three weeks leads me to suggest that you add to your PM holdings today. Supply-demand issues, the emptying of Western depositories and cutbacks in capex and E&D prompted by 2Q shorting and panic-selling have created a situation that is rapidly forcing prices higher. Seasonality too is an important factor as we enter the 3-4 month period when PMs outperform. Look at the May - November chart for 2012 and you will see the point.

Here are some of the best companies, ETFs and ETPs in the PM space. Five- ten of these should be in your "Portfolio of Kings," companies for surviving years of turbulence, low growth and declining living standards. I have begun identifying these sectors and companies here, here and here. I began preparing this strategy here in discussing the relation of Europe's Woes to companies in the global power matrix.

This article primarily considers silver (NYSEARCA:SLV) whose relation to the world economy and monetary issues I discussed here. In recent weeks it has been trading at a much stronger ratio to gold. Last year, the gold/silver price ratio was 54 - 57:1. In 1H 2014 the ratio rose to 65:1. In recent weeks, for example August 23, the ratio has closed to 20:1 with the historic ratio being 16:1. The highs of early 2-3Q 2011 likely will be surpassed in 4Q 2014 by the best PM companies.

I will look mainly at Silver Wheaton (SLW), First Majestic Silver (NYSE:AG), Endeavour Silver (NYSE:EXK), Fortuna Silver (NYSE:FSM) and glance at Silver Standard Resources (NASDAQ:SSRI) and Tahoe Resources (NYSE:TAHO). I list TAHO last because it is the only one of this group not yet producing, although it is on schedule for production 1Q 2014. At Escobal in southern Guatemala it has one of the three major world sites for silver: 367 million oz. proven reserves and c. 35 million oz. probable reserves. Only the Pitarilla, Mexico site of SSRI with about 479 million oz. probable reserves and Barrick Gold's Pascua Lama (676 million proven oz. silver and 14 million oz gold) are greater.

SLW is the only one of these companies to pay a dividend, 1.6%, that varies with quarterly revenues. That is nice and SLW is a great outfit but one buys silver companies for growth. SLW is growing revenues, 28% Y/o/Y 2Q and 32-49 million oz/ year projected for the next three years. The heart of its appeal is the "streaming" model it pioneered. SLW helps subsidize mine development for properties it considers rich for the right to purchase a portion ("stream") of its silver or gold output at an average cost of $4.14 oz. silver and $392 oz. gold. With silver touching $24/oz Friday and gold $1400, trending higher amid strongly positive near and long-term fundamentals, the merit of the model is clear. SLW already has recovered 56% from its June 26 low at $17.75 and should be bought before it hits $30.

The HSBC "flash PMI" for China shows it rose significantly June to July from 47.7 (contraction) to 50.1. Most analysts again are looking for 7 to 7.5% growth from China and its appetite for silver as a monetary and industrial metal is enormous. SLW next year likely will surpass its 2012 high at $41.30 which matched its 3Q 2011 high. Dr. Stephen Leeb looks at China's growth and hunger for commodities, including PMs and sees Ag prices above $120/oz. Ron Rosen with 50 years+ market experience suggests prices of $150/oz based on the rises of PMs in the bear markets of 1968-82 and 1929-32. My analyses (see my archive) of the legs of the 12-year PM bull and the depth and duration of its retracements suggests prices of $90/oz. by 3Q 2014.

AG is the largest producer of the miners noted above. Its revenue is 12 x total debt and the cash flow from its five producing mines is 5.5 x its debt. Its 2Q 2013 revenues showed a 44% Y/o/Y increase despite holding back 150k silver oz. because of last quarter's artificially depressed prices. Shareholders will reap the benefits when AG sells this surplus into the market at substantially higher prices. AG has five development projects (all in Mexico) and six exploration properties covering 5240 hectares (13k acres) in Jalisco, Etzatlan in West Central Mexico, a center of mining since the 1700s. Mining ended there in 1935 until improved technologies in the last decade revived the area's value.

EXK also has excellent profitability with revenues similar to AG at 6.5 x its total debt. Its cash flow is about 68% that of AG and at .26 has half the EPS and not quite as strong a quick ratio according to the SA portfolio tool metrics. It has seven E & D sites and its directors have decades of experience in mining. Beginning 2013 it had 7.4 million oz. proven and probable reserves of silver and 105k of gold at its three mines. EXK's measured and indicated reserves a bit more than double its current proven reserves: 9.2 million oz. silver and 140k oz. gold. EXK is into its tenth straight year of increasing production and has no long term debt. Its cash costs are about $7/oz which means an all-in sustaining cost between $10-11 which is particularly good with rising PM prices. Exploration near its Bolanitos site in July discovered veins of high-grade mineralization.

FSM is a junior miner with zero debt and six years of increasing production at its mines in Caylloma, Peru and San Jose in Mexico's southernmost state of Oaxaca, just north of Guatemala. Its 2012 production was 4 million oz. silver and 20.7k oz. gold. It is on target for 2.4 million oz. silver at San Jose, a very low cost mine in 2013 where its proven and probable reserves total 20.4 million oz. silver and 170k oz. gold. Its reports cash costs of $7.84 a silver equivalent oz. net by-product credit. Adjacent to the mine it has 150k acres with significant mineralization. Caylloma also produces lead (17.9 million lbs in 2012) and zinc (22.4 million lbs in 2012).

As part of your due diligence on a company it is useful to examine the credentials of the board of directors. EXK and FSM shine in this area. EXK's six main board members, starting with CEO Brad Cooke have degrees in geology and 22 - 35 years experience in mining at both junior and mid-tier miners. The two Mexican members of the board have degrees in geology and have been working at the Guanavici mine for ten years before EXK was founded in 2004. They have been with EXK from inception.

Simon Ridgway, Chairman of the Board of FSM has nearly four decades experience in prospecting in the Yukon and Central America and in mine financing. Geological Engineer Jorge Ganoza, an FSM co-founder in 2004 has two decades experience in mining geology and development. Co-founder and Director Mario Szotlender has a degree in international relations, 30 years expertise in Latin American mineral E&D and also serves on the Board of EXK. Geological Engineer Tomas Guerrero also has over 30 years experience in the field including a decade as Director of Explorations for the Hochschild Group (OTCPK:HCHDF). He is a member of the SEG (Society of Economic Geologists - USA) and SME (Society of Mining Engineers - USA).

The distinction and importance in the mining and political fields for AG is Co-director Ramon Davila who has degrees in Mining and Metallurgy, Minerals Economics and Engineering. From 1978-87 he worked for Industria Penoles, Mexico's largest miner and the largest weighting, about 12% in the Global X Silver Miners ETF (NYSEARCA:SIL). He then worked for Pan American Silver (NASDAQ:PAAS) and Luismin. Equally important to AG's continuing success is that he is a Board Member for the Chamber of Mines, Mexico and a past President of Mexico's Association of Mining Metallurgists and Geologists. Along with First Majestic's policy of community enrichment and having a Mexican director at each of its 5 producing mines, the prominence of Mr. Davila in Mexican and American mining helps insure the company's continued strong growth.

Note that SIL gives each of these three outstanding companies, two mid-tiers and a junior, prominent place in its holdings: about 4.8% each for AG and EXK and 3.8% for junior FSM as of May 1. SLW shares the top weighting with Industrias Penoles. Two other fine companies, Silver Standard Resources , with a producing site and an immense development project at Pitarilla, Mexico and TAHO (debt-free) have weightings of about 4.3% and 5.2% respectively in SIL which may be considered a vote of confidence in the progress and value of TAHO's Escobal mine. In my view all these companies and SIL are strong buys because of macro, secular, monetary and seasonal factors. One would do well to have positions in SLW, AG, EXK and FSM and consider the immense potential of TAHO and SSRI, the latter already producing about 1.7 million oz. silver / year. Include three or four of them in a portfolio to ride out coming storms.

I will review gold miners in my next piece. In brief, mid-tier producers Eldorado Gold (NYSE:EGO) and Yamana Gold (NYSE:AUY) are the best of class. Their revenue / debt ratios are 2.2/1 and 2.7/1 respectively with EGO revenue growth listed at 17%. It has cash and equivalents 5:4 of debt. The major gold miner that now is deep value is Barrick (NYSE:ABX) whose enormous reserves and low costs have prompted TD Securities to raise its guidance to "Buy" with a 2013 price target of $25. ABX closed 8/23 at $20.07. I reviewed its prospects here and here. It has scaled back development, saving $3.5 billion in 2013-14 and has added $800 million cash in the past two weeks by selling Barrick Energy in Canada and three of its Australian mines to Gold Fields (NYSE:GFI). Its main output is from North America and, in South America, Lagunas Norte in Peru and Veladero, Argentina with Pascua Lama slated for production in 2016.

Trading tip: When PM issues you hold exceed their 2012 highs, monitor the macro situation including supply-and-demand, retail and CB buying, increasing tech-industrial applications for silver and the geopolitical situation for each company. At that point, consider cashing part of your gains: do not sell out unless a downward pattern emerges. It is the nature of the sector to have enormous seasonal and Y/o/Y volatility and one always can switch to other sectors and buy back later as the savviest investors began doing the latter half of April. Also consider adding to ETPs backed 100% by physical gold (NYSEARCA:PHYS) and silver (NYSEARCA:PSLV). They have re-traced only 28% to their 52-week highs.

An exception to the tactic of cashing in some gains is privately held physical silver or gold which should be sold only in emergencies. In the big chill to come, what Spengler termed the end stage or "Petrifact" of the West when finance destroys democracy and cultural norms (a stage in view as Keith Barron and others, like Robert Fitzwilson note, these holdings may help sustain life).

Disclosure: I am long AG, SIL, TAHO. 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.

Additional disclosure: I own precious metals companies in mutual funds, ETFs and separately.

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