The Case for Precious Metals Miners

The Case for Precious Metals Miners
You don’t need me to tell you.  Precious metals mining shares have been nothing short of a historic fiasco over the past couple of years.  Specifically, gold is up 25% since the end of 2010, while the ETF of large cap miners, the GDX, is down 11%.  That is not just under-performance, that is catastrophic.

Now there are many reasons for this horrific performance, but in my mind the main reasons have been; political risk (the confiscation of mines or forced renegotiation of contracts), rising cost structure (both energy and personnel), and massive execution shortfalls from many of the major precious metals miners on the planet.

In order to decide whether the group may make sense at the moment, it is key to analyze the risks above.  As far as political risk, I think it is as significant a risk as ever, but one that will never go away.  Does that mean you should never buy the space?  In my view it does not.  What matters is if this risk has been embedded sufficiently in the valuations and I believe it has.

As far as the rising cost structure, again this is still here, but with the Saudis pumping all out at the moment to help Obama ahead of the elections, margins should be expanding right now.  Furthermore, it is really about whether the metals can rising significantly more than input costs and, after a year of consolidation, I believe they certainly will.

Finally, I think the last risk has been reduced substantially.  Most of the miners have already blown up in one way or the other and the investor base has given up on the space.  There is even a large contingency of the “gold bug” universe that completely refuses to touch the miners.  I am not in this camp, but since it exists even within the most hard core precious metals bulls, I think this is a positive sign for the miners going forward.

In addition, how about the potential for rapidly growing dividends.  In all of the weakness as of late, it seems people forget that Newmont Mining’s gold linked dividend really starts kicking in above $1,800/oz and we are almost there.  At $1,800 gold NEM has promised to pay $2.00 a share, which is a yield of 3.5% at the current stock price.  Here is the full table on the dividend policy.

What About the Juniors?
If you think the large-cap miners have been bad, an atomic explosion has occurred in the junior space.  While the GDX is down 11% while gold rallied 25%, the ETF called GDXJ of junior miners is down 37% over the same time frame.  Financing has been a major issue in this space, but as I mentioned yesterday, the Samsung deal with Cluff Gold bodes very well for the future.

Last but certainly not least, the story out last night about a tungsten filled gold bar found in NYC is extraordinarily bullish for the miners.  No one knows how much of the gold out there is fake, but clearly some is.  Also, it is clear that there is also real gold out there, and this gold comes from mines.  As a result, even if you don’t like the space, this gives a clear catalyst to want to diversify some of your exposure into the mining shares for the first time in years.  I would also expect governments and wealthy individuals to make deals with mines similar to Samsung.  This, combined with M&A could spark a massive rally in the junior miners in particular.

Mining Shares Versus Gold Are Breaking Out

The chart above shows the ratio of a gold mining index (the HUI) versus the price of gold.  You can see the devastation in the past couple of years, but it has also apparently broken out.  Due to the catalysts I mentioned above, I think it could continue to do so.  As always, we shall see.

Hope this helps,
Mike

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