Do the Billions Spent Make Miners Cheap or Dangerous?

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Friday's trading session saw a halt in trading of two major precious-metals companies on news that the Chilean government was shutting down operations at the Pascua Lama mine. Barrick Gold (NYSE: ABX  ) , which operates the mine, was halted first, with joint-venture partner Silver Wheaton (NYSE: SLW  ) halted a few minutes later. The mine, which Barrick has already spent more than $5 billion developing, represents one of the largest resources for gold and silver in the world.

The bigger question that Friday's events raise is whether precious-metals companies are becoming cheap or dangerous at current levels. Barrick is down about 40% this year, and while others such as Goldcorp (NYSE: GG  ) and Newmont Mining (NYSE: NEM  ) are down less, they have still slid by roughly 20% each. Gold as a commodity is down more than 17% this year, as represented by the SPDR Gold Trust (NYSEMKT: GLD  ) . In addition, global macroeconomic events are aligning to make the future direction of precious metals very uncertain, at the very least increasing the volatility and risk associated with these types of investments.

What happened in Chile
The reason given for the stoppage at the Pascua Lama mine was the water handling being employed at that location. Barrick had agreed to meet certain standards that local authorities now claim have not been met. Pascua Lama is an open-pit mining operation that uses large quantities of water; if this water is contaminated and allowed to run off, it can contaminate the local water table. According to the Chilean press, Barrick will be fined 8 billion Chilean pesos, or $16.4 million, for the violations.

The news represents a significant blow to Barrick and its JV partner Silver Wheaton. Barrick has poured money into the mine, which already has 18 million ounces of proven and probable gold reserves and 676 million ounces of silver. These levels make the location one of the largest sources of gold and silver anywhere. Both Barrick and Silver Wheaton closed near the day's lows after they resumed trading.

The bigger picture
At their most recent earnings announcements, Goldcorp and Newmont both reported disappointing results. These companies have come under similar pressures to the ones Barrick faces. Goldcorp reiterated its full-year earnings view, but with recent developments from the Federal Reserve, the long-term prospects look mixed. Earlier in the week, minutes from the Federal Open Market Committee meeting suggest that a growing number of officials at the Fed favor slowing or ending quantitative easing; this news is generally considered bearish for precious metals, including GLD.

On the other side of the argument is the that there is convincing evidence that the current run in the stock market is driven by the current Fed policy. If the policy reverses, it may create a vacuum that drives stocks sharply lower. A significant fall in stocks will probably improve the picture for both gold and silver, making the current sell-off a potential buying opportunity.

With all of these swirling forces, the one probability is that volatility will increase. Increased volatility means increased risk, but the increased risk can be mitigated by taking a smaller position. Being aware of the forces at work is critical. Overall, maintaining an allocation to gold and silver is prudent, but allowing for the risks at play is paramount.

As a way to stay allocated in the space, if you're looking for a company whose success is determined by the metals market, but without involving itself in the risks of physically mining the metals, then Silver Wheaton provides a unique play on the future of silver. SLW chooses to finance the mining of silver; it has grown sales and net income every year since 2008, and also has increased competitive advantages over its limited peer group. To learn more about Silver Wheaton, click here now to access The Motley Fool's premium research report on the company.

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  • Report this Comment On May 27, 2013, at 11:23 PM, techy46 wrote:

    The Pascua Lama mine is a wakeup call for Barric Gold and I'm thinking that's why they've change management from the top all the way down to that mine. You sure don't want to invest $5 billion in a dry hole or have a gusher like BP did in the Gulf. Capital intensive raw materials exploration and production are rsiky businesses whether the results are copper, gold, oil or silver. The rewards equal the investment and risks.

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