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Gold and Silver Stocks Get Slammed, but They're Looking Fundamentally Fabulous

By Sean Williams - May 24, 2016 at 6:42PM

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Metal miners face another meltdown on rate hike fears, but this could represent a good buying opportunity for investors.

It's been a topsy-turvy year for stocks in general, but two of the most surprising standouts have been gold and silver mining stocks, which are the year's top performers. With the exception of just one gold miner, all of the 40 largest gold and silver miners are up by at least 25% year to date.

Gold and silver miners suffer a meltdown

But today was not the best day for mining investors. On a per ounce basis, spot gold fell $20 from its prior-day New York close to $1,228, whereas silver dipped once again to $16.19 an ounce, a 1% decline from its prior-day close.

The recent pressure in metals can be traced to rising expectations of an interest rate hike in June by the Federal Reserve. After raising lending rates once last year for the first time in nearly a decade, the Fed had planned on boosting rates four times in 2016, but it abandoned that approach earlier this year after fourth-quarter GDP growth came in below expectations. Mining investors had been counting on the Fed to hold off on further rate hikes until perhaps later in the year, but new signals from the Federal Reserve minutes suggest  a rate hike is very much on the table for its next meeting in June.

Higher lending rates will more than likely boost bond yields and push the U.S. dollar higher, two things that work against gold prices (and silver tends to follow gold). As lending rates rise, the allure of buying interest-bearing assets increases, which is bad news for physical gold since it pays no dividend.

This worry is readily apparent throughout the sector, with the following miners plunging on the weakness in metal prices:

  • Kinross Gold (KGC -0.30%): down as much as 11%.
  • Richmont Mines (NYSEMKT: RIC): down as much as 13%.
  • Harmony Gold (HMY 1.89%): down as much as 10%.
  • Endeavour Silver (EXK -0.99%): down as much as 10%.
  • Great Panther Silver (GPL 1.60%): down as much as 11%.

Like I said: not a great day to be a mining investor.

Physical gold and silver could still head higher

However, there are reasons to believe  this is merely a temporary bump in the road from both a macroeconomic and fundamental perspective.

For instance, in the first quarter, U.S. GDP grew by a mere 0.5%, which echoed the initial weakness we saw in Q4 2015 GDP, which, before adjustments, had grown by only 0.7%. The consumer simply isn't spending despite consistently low lending rates, which is worrisome. It would be my opinion that the Fed doesn't have room to get very aggressive with rate hikes given the subpar GDP growth and low inflation we're currently seeing based on the data.

Additionally, the Federal Reserve plans to wait on monthly economic data to determine if a rate hike is appropriate. There are no guarantees  this data is going to be favorable. Manufacturing data has been weaker on a year-over-year basis, and I suspect it wouldn't take much for the Fed to revert back to its cautious approach on lending rates.

Supply and demand are also working in favor of physical gold and silver. Central banks have been increasing their purchases of physical gold, and steady growth in the solar industry, which requires silver for its heat resistance and electrical conductivity, should help buoy silver.

And of course, we're witnessing genuine fundamental improvements in operating efficiency from nearly all gold and silver miners, which is what's making them especially attractive. Miners are being much smarter about what they produce, focusing on higher ore grades and quality over simply boosting quantity.

Metal miners are looking fundamentally fabulous

Today's top losers provide a perfect example of metal miners that have focused on reducing their costs to fully take advantage of this recent uptick in gold and silver prices.

Kinross Gold, which was also hit with news of a strike at its Tasiast Mine in Mauritania this morning, announced during the first quarter that it expected its full-year all-in sustaining costs (AISC), an important measure of mining efficiency that helps investors determine the true costs of mining costs and maintenance, would be about $940 an ounce at the midpoint. This prospective dip in full-year AISC compared to the $963 per gold equivalent ounce (GEO) it reported in Q1 2016 comes in spite of an increase in its capital expenditures to expand production and lower costs at its Tasiast Mine. Kinross is putting its overzealous spending in the rearview mirror and is now focusing on only its top-tier projects.

Image source: Kinross Gold.

Richmont is another perfect example of focusing on quality over quantity (even if its production happened to improve). In the first quarter, it delivered a record $52.6 million worth of revenue, mainly on account of a 147% increase in Island Gold production due to substantially higher ore grades. Best of all, AISC fell to just $801 an ounce, a 12% year-over-year decline. Richmont has also benefited from Canadian dollar weakness on a year-over-year basis, but we're more importantly seeing fundamental improvements in recovery rates and smarter spending habits.

Harmony Gold also experienced a nice boost in profits thanks to currency moves -- in its case, a falling Rand in South Africa, where it mines most of its bullion. In its fiscal second quarter, Harmony reported a profit of about $4.7 million, which compared to a loss in the previous year of $33.4 million. It did so by improving production on a year-over-year basis by 2% and reducing its AISC by 15%, in U.S. dollar terms, to $950 an ounce. Harmony also wound up repaying nearly a third of its outstanding debt during Q2, which is going to be critical to improving its long-term flexibility.

Image source: Endeavour Silver.

However, cost-cutting isn't exclusive to gold miners. In spite of weaker production and a double-digit decrease in realized silver prices from Endeavour Silver in Q1, it managed to produce a slightly higher year-over-year profit as AISC fell 17% to $11.12 an ounce, net of gold credits. This was mostly due to the suspension of exploration and development activities at Bolanitos and El Cubo, and it demonstrates that Endeavour is thinking about working smarter, not harder, with its cash on hand.

Even the tiny Great Panther Silver has been delivering substantive cost improvements on a year-over-year basis. AISC in its most recent quarter plunged 38% to $13.76 an ounce, all while it was able to boost gold production by 19% to nearly 5,600 ounces. Although Great Panther still lost money during the quarter, its improved working capital and reduced costs set it up to potentially deliver profits for the remaining three quarters of 2016 based on today's physical metal prices.

You probably can't throw a dart and expect success in the mining sector, but things are definitely improving, which means investors should be giving serious consideration to adding lower-cost, higher-efficiency miners to their investment portfolios.

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Stocks Mentioned

Kinross Gold Corporation Stock Quote
Kinross Gold Corporation
$3.34 (-0.30%) $0.01
Endeavour Silver Corp. Stock Quote
Endeavour Silver Corp.
$2.99 (-0.99%) $0.03
Great Panther Mining Limited Stock Quote
Great Panther Mining Limited
$0.13 (1.60%) $0.00
Harmony Gold Mining Company Limited Stock Quote
Harmony Gold Mining Company Limited
$3.24 (1.89%) $0.06

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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