Precious Metals Mining Stocks Will Bottom Before the Rest of the Market

by: Danny Furman

Stocks are struggling to find support in recent trading, with sell offs spanning all sectors and corners of the globe. Emerging markets have led the way down, many of which have failed to reach late 2010 peaks thus far in 2011. Agricultural and industrial commodities, along with shares of producers, reached multi-year peaks in mid-February while precious metals, energy and U.S. stock indexes rallied through April.

"Sell in May" certainly sums up market behavior as the month approaches its close. Headlining the long list of losers for May is dear friend silver, which, as predicted, has traded as low as $32/oz after flirting with $50 in late April. While silver bugs remain hyper-bullish on the metal, traders have jumped ship and are now shorting with leverage and conviction. Bears argue that silver's value as money has been eliminated over time and industrial demand does not explain the current price. It is therefore speculation from bugs, cats and similarly intelligent humans that has created an epic bubble in the white metal.

Fiat currencies have come and gone for thousands of years, while gold and silver have remained highly, though not consistently, valued. The economic boom of the late 20th century was one of exponential technological progress. Leaders and innovators created and sold dreams to enamored followers. The United States lead the way by using dollar strength to purchase foreign labor and resources at heavy relative discounts. Time, technology and education have leveled the playing field across the globe. Progressive and younger generations have a less idealized, better overall understanding of technology and economics than Keynesians and fight urges to spend, save, think, act and invest impulsively. The era of consumer driven Western economies feeding off submissive emerging markets is coming to an end.

A return to normal, which apparently means one country ruling the world, has never been in the cards. Since the technology bubble burst from 2000 to 2002, almost every upward move in the S&P 500 (NYSEARCA:SPY) has been outdone by gold (NYSEARCA:GLD), which in turn has been outdone by silver (NYSEARCA:SLV). Gold was under $300/oz and silver was below $5 at the beginning of 2002. Emerging market stocks have also massively outperformed shares of companies from developed economies, with Chinese and Brazilian markets each gaining over 300% from 2005 to 2008 alone. A global convergence in asset prices and competition is the result of investors seeking value and scarcity rather than monopolistic or political advantages.

Asset markets crashed in late 2008, and while the vast majority of stocks and commodities continued selling off until QE1 was implemented in March 2009, gold and silver bounced resiliently in November 2008. From then til the announcement of QE1 silver gained over 40% and gold rallied nearly 30%. In 2010 May's "flash crash" and subsequent selling sent SPY shares down to $109 that month, before buying throughout the following year helped the ETF finish April 2011 at $143. During the same time gold went from $1150 to $1550 and silver from $18 to $47.

As has been the case since 2002, production and innovation are declining in the United States. Job growth is coming from the public sector, which is deeply indebted and fundamentally anti-competitive. Unless austerity measures are taken to reduce deficits and rebuild a sustainable economy, the U.S. d5ollar is en route to the inferno.

Markets are currently shaky with QE2 coming to an end, commodities inflation causing margin squeezes for producers and killing demand from consumers, chaos in the Middle East, eurozone economic turmoil and Japan melting down. To fight deflationary forces, the United States government and central bank are buying assets, providing incentives for consumers and business owners, and creating public jobs. While federal propping of the economy does little to propel consumer demand beyond subsistence, it does severely devalue the dollar by inflating the money supply and changing the underlying economy. Not long ago the United States was a net saver and exporter, neither of which it is today.

With silver down 35% and gold off $70/oz over the last month, along with a struggling overall stock market, shares of mining companies have been hit hard. Patient, conservative investors may wish to stay on the sidelines and allocate capital appropriately once political and fiscal plans are finalized. Now may be the time to pile into mining stocks, however, as sell offs may be sharp but tend not to last in the sector.

Gold has pulled back 3%+ from its April peak and remains the safest, least volatile way to own precious metals. Investors without exposure to silver should use the recent sell off to initiate a position, however gold mining stocks look like the real bargains at the moment. Crude oil has pulled back over 10% in recent weeks and is a major input cost for miners. With gold off less than 4%, sell offs in mining stocks appear overdone and exceed 10% in many cases. Goldcorp (NYSE:GG), the world's leading low cost producer, has fallen from $56 to $48. Diversified large cap Kinross Gold (NYSE:KGC) trades at multi-year lows, pays a regular dividend and has a trailing P/E under 15. Barrick (NYSE:ABX) and Newmont Mining (NYSE:NEM) are also leading producers trading under 15x earnings. Exploration and junior mining stocks have pulled back hard enough to permanently scare some speculators who were late to the game away from the sector for good. Some hard hit names with loads of shiny potential are Rubicon Minerals (RBY), Richmont Mines (NYSEMKT:RIC), Northern Dynasty Minerals (NYSEMKT:NAK) and Alexco (NYSEMKT:AXU). GDX and GDXJ are diversified ETF options, both currently 10% or more cheaper than a month ago, for investors looking for gold mining exposure. Even the most profitable silver miners, such as Silver Standard Resources (NASDAQ:SSRI) and Silvermetals (NYSE:SVM) have been demolished in price during the recent sell off, losing more than the commodity itself. They offer they greatest upside potential as well as the most downside risk of investment options in the precious metals and mining sector.

Disclosure: I am long SLV.