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If You Were Going to Buy a Mining Stock, Which Would It Be?

by John Rubino on December 4, 2013 · 17 comments

Let’s say you’ve got some traditional mutual funds full of stocks and bonds and they’re way up. You’re worried by all the taper talk and the charts that show share prices and margin debt back up to pre-crash levels, and you’re wondering whether it’s time to redirect some of that capital to someplace that no one is calling a bubble.

Meanwhile, you’ve noticed that precious metals mining stocks are in another of their periodic corrections, with this one looking a lot like 2008’s bloodbath — which was followed by an epic bull market:

HUI final

But with gold and silver below the production cost of a lot of miners, there’s a ton of risk to go with the seemingly huge upside. So committing to individual miners is terrifying. Still, that’s how it always looks at the bottom.

So if you’re going to buy one, which would it be?

Let’s start with the premise that at a bear market bottom investors, having been faked out so many times on the way down, don’t trust the turn. So to the extent that they buy anything, they buy the safest names. If the miners keep to this pattern, next year will be good for the best and mediocre for the rest. And in mining the safest bets are the royalty and streaming companies that don’t actually mine metal themselves but contract with other mines to take part of their future output. They do this in a variety of ways ranging from buying up existing royalty agreements that call for a given number of ounces delivered over a specified period of time, to in effect making equity investments in mines in return for some portion of future production. The first is passive investing, the second more like venture capital.

The biggest companies in this space have been able to gain interests in lots of mines on generally favorable terms. Here are the three to consider:

Royalty companies

Not Risk-Free
A lot of these companies’ investments depend on mines expanding or continuing to produce as expected. Should the price of gold and silver fall much from here there will be wholesale project cancellations and mine shutdowns, which would mean less cash flow from their positions. This is a very real risk, but even so, the impact on the royalty/streaming companies would be less than on the typical miner because the former have spread their bets among so many different mines.

The other issue is the availability of good investments going forward. The royalty companies have to invest their cash at rates that exceed their cost of capital. Such deals are scarce in this environment and will get scarcer if metals prices don’t recover. Here again, though, we’re talking about diminishing cash flow, not an existential threat.

Meanwhile, in a really bad market these companies become the king makers in the industry, deciding which juniors live or die and using that power to cut deals that become hugely favorable when prices revive and those new mines are developed.

To sum up, these companies are not as safe as owning bullion intelligently stored, but they’re safer than the typical miner, with considerable upside margin over metals prices if things turn around from here.

  • pipefit9

    The three companies you mention have the advantage, from a technical standpoint, of having put in a higher low since June. You can’t say the same for the hui, xau, gdxj, and most other gold stock indexes. But they’re beat up enough to remove a good part of the risk.

    Basically, I think your premise is correct. The royalty stream type outfits offer the better risk/reward here. Even if we get a pretty decent gold rally, say $150/oz, a lot of the producers will still be unprofitable.

    • MacFly1

      you mean $1,150, right?

      • pipefit9

        @MacFly–I was trying to say ‘AN INCREASE from PRESENT GOLD PRICES of $150/oz’. That would take gold to $1400/oz, which is not enough for many miners to make money. But royalty gold stocks, like John mentioned, would be in much better shape.

        If we get an increase in gold price of $1000/oz or more, to $2250/oz, I would expect almost all gold stocks to be exploding higher.

        So you can see the degree to which gold has been pounded lower. I’m fairly certain a 1-world currency is inevitable. The present system isn’t working. But they can’t just roll it out on a whim. This sort of thing takes a lot of preparation. In the mean time, they don’t want gold lurching higher. That would lead to panic.

  • PaperIsPoverty

    I’m trying to think why metals miners would not be dragged even further down in a general stocks sell-off. I don’t think that technical factors would protect them, but it could be that this time gold and silver themselves rally during a crisis, rather than selling off as in 2008. After all, who but stackers even own gold and silver anymore? Anyone who owns them wants them as insurance, either against money printing or against counterparty risk or both, and they’re not likely to sell during a financial crash. So perhaps metals, and along with them the miners, could rally while the rest of the financial world falls apart. But mining stocks still feel very risky to me at this moment.

    Of course this is my issue as an investor… I’m so bearish I’m paralyzed. I just wish we’d clear the system again and then I could delve into miners and stay there for the long, re-inflationary haul. It’s amazing how well they’ve managed perceptions & how long they’ve kept up this illusion of economic normality.

    • Sueychop

      I bought Yamana in 2007 and sold it all in 2008. 90% profit. That’s why. You just gotta get that feelin’ for when to sell (bears make money, bulls make money, pigs get slaughtered, etc.). Buy Yamana now and sell 50% at $20 per share. Let the rest up to around $30, keep the last 10% and have fun trying to call the top.

    • Perplexed

      IMO They would initially but once the speculators are out of the picture I think a lot of people will realize that fiat currencies are not equal to the value of precious metals and will thus place their money in them and their mining stocks.

  • Bruce C

    Which ming stock would I buy (if I had to)?

    Off hand I don’t know. I don’t know enough about the business or the individual companies or their management teams, and I’m not interested enough in all that to learn. That said, if I had to buy one I guess I would choose the one with the most assets, the least debt, and that pays an average dividend – and preferably one that has increased steadily for at least the last 5 years.

    But I agree with PaperIsPoverty that mining shares will probably fall along with all other equities, as they have for the last few years whenever there was a general market sell-off, so I’d be as reluctant to buy mining shares as anything else in this market at this time. Furthermore, considering how desperate and lawless governments and central banks have become I don’t see how mining companies would be “allowed” to prosper if everything else is declining. If financial elites don’t want the gold price to increase to manage perceptions, then I don’t think they’ll tolerate ming companies doing well either. (Given the small market caps of miners, shorting them before orchestrated sell-offs would be extremely easy.) Governments wouldl probably want some piece of the action too a.k.a. taxes, nationalizations, confiscations, environmental restrictions or fines, etc.

    • Sueychop

      They spike up in the initial crash, then fall later when things start to even out. That’s when you sell (which means you need to buy it now, you know, buy low, sell high?). Don’t throw your whole investment into it but at least put some mad money there.

      • Bruce C

        I suppose, but the irony is that all you may gain is still only fiat currency which may very well be heading to its intrinsic value as the crash plays out. Nominal gains but ultimately real losses.

        I don’t mean to dump on mining stocks per se, but I just question the actual practicality of the premise that if gold goes up then so will the mining stocks. I think mining stocks in particular embroil some of the most confounding dilemmas of paper vs physical so from an outsider’s perspective I just think its too complicated to predict how things would play out if/when either the “gold price” (paper) or the “price of gold” (physical) starts to move higher.

        But from a short-term trader’s perspective none of that may matter, including which particular mining company’s stock you choose.

        • MacFly1

          Absolutely right and also its hair raising trying to make money that way and one little wrong move and its gone. Gold will go up at some point, and spike higher to the coming MOUNTAIN of the gold price and gold miners will spike with it just like in 2008. Also, that’s why you’ve got to have that room full of silver bars (1 oz. 10 oz. etc.), that room full of guns, that room full of bullets, that room full of beans, etc.

  • Dale Holmgren

    Semafo.

  • James Woroble Jr

    Nova Gold [NG]

  • dan

    if and when we have a ‘currency crisis’…all paper goes to the ‘shit bowl’……only hard assets survive…and there will be NO one with anything left to invest in since all stocks are paper and will be worthless…or nationalized by the banksters …revenge will be bitter…but cleansing….which this country dearly needs….the ones and their minions that have created our demise will be held to a higher standard then in past history…….I speak not of American history but that of France and Russia…….as in Marie and the czars

  • Anthony J. Alfidi

    Many junior mining companies are going to be out of business when rising interest rates lead to higher financing costs. They’re also going to be hurt when AISC reporting raises the hurdle rate for greenfield projects. I still like Allied Nevada (ANV) among junior gold producers but I’m holding off on buying it. I thought they were doing everything right until recently.

    • MacFly1

      For juniors Timmins gold is an exceptional buy right now at one buck a share. Might wait till this thing bottoms out for sure, though (it will).

  • Dont Mention The War

    Brigus Gold Corp (TSE:BRD)

  • http://www.americanbullion.com/ Tammy Jones

    This is a really interesting article, thank you for sharing. The supply of gold these days seems just as treacherous as quantitative easing, inflation, and every else going on that’s affecting the stock market. Everyone just needs to be smart and invest in something that’s going to last. Really enjoyed your article, keep up the good work!

    Tammy


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