Neutral on Mining Shares? Sell Mexico, Buy Canada

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President Enrique Pena Nieto's fiscal reform bill is striking fear in the hearts and minds of mining executives operating in Mexico. Attached to the 2014 budget, the bill could be signed by as early as mid-November. Within it, the Mexican government has proposed a 7.5% mining royalty as a percentage of EBITDA. Once considered one of the most mining-friendly destinations, this proposal has industry executives singing a different tune.

Brad Cooke, CEO of Endeavour Silver (NYSE: EXK  ) has stated the combination of this tax increase and essential reinvestment into the mines would cost his company about 90% of their current profits . Granted, if silver prices continue higher some of the perceived pain may subside, but what if they don't? This tax could squeeze the life out of mid-tier mining firms, such as Endeavour, that have gone all-in on Mexico.

Grupo Mexico owns 80% of Southern Copper (NYSE: SCCO  ) , the largest copper producer in Mexico with seven mines and two smelters. With 67 million tons of copper reserves (50% more than Freeport), Southern Copper is projecting a long, long, life of mining in Mexico -- 105 years! . Talk about looking into the future. While Southern Copper does have diversification with its Peruvian assets, they have invested their de los nietos (grandchildren's) future into Mexico. With so much at stake, they don't like the sounds of anyone drilling into their profit margins. Call it posturing or call it an open threat, but they have warned anyone who cares to listen that they will be forced to redirect $5.4 billion of planned investment if the 7.5% royalties become law.

Estas despedido
Fingers crossed, the differing interests will be able to strike a mutual agreement and play nice. If they can't, the miners themselves may not be the only thing getting squeezed. Mexico is the world's largest producer of physical silver (which some argue is already in a tight-supply situation). Also, it's estimated that nearly 2.5 million workers are benefiting directly or indirectly from mining operations. If the new royalty tax is passed, many of them will likely be squeezed out of a job.

Meanwhile, all is quiet on the political front in Canada. Mining companies there should be safe from any new taxation proposals until October 2015 . While the markets are forward looking, Canadians will not be showing up at the polls to vote for their favorite politician(s) until then.

O Canada
Make no mistake about it, the "O" I'm referring to stands for the O Canada national anthem, not the O in Osisko Mining (TSX: OSK  ) . Now that we've cleared that up, Osisko is just one example of a Canadian levered mining company. Osisko owns one of Canada's largest open-pit bulk tonnage mining operations. Its estimated production for 2013 is between 485,000 and 510,000 ounces . Gold prices willing, it should be mining its 10 million ounce (310 Mt at 1 g/t Au) reserve base for many years to come . Underneath all that, Osisko has a strategic land package in Kirkland Lake, Ontario (230 square km)— a famous gold camp that has produced 50 million ounces of gold in its history.

Kerr-Sulphurets-Mitchell (KSM) may not be the most elegantly named gold deposit in the world, but it is one of the largest . Owned by Seabridge Gold (NYSE: SA  ) , a company that is famous, or infamous, for having 0.98 ounces of gold reserves per common share . One could argue that Seabridge has done a great job of minimizing share dilution; one could also argue the KSM project may never be built into a mine. Size isn't everything; the grades of 0.79 g/t Au and 0.23% Cu are on the lower end. Knowing that, its Courageous Lake project (more elegantly named) is also quite large, and grades there are estimated to be twice that of Osisko's mine.

Bottom Line
If you are neutral on mining stocks, selling Mexico and buying Canada may not be a bad idea. However, the strategy will only be relevant as long as the uncertainty surrounds the new tax regime in Mexico. I couldn't find any ETFs that will get the job done efficiently, so you will probably want to find a few more Mexican and Canadian levered (pure-play) mining companies to balance the trade.

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Related Tickers

9/29/2016 4:03 PM
EXK $5.17 Down +0.00 +0.00%
Endeavour Silver CAPS Rating: **
OSK $3.07 Down -0.02 -0.65%
SA $11.19 Down -0.05 -0.44%
Seabridge Gold CAPS Rating: **
SCCO $26.43 Down -0.25 -0.94%
Southern Copper CAPS Rating: ****