This article was updated on Nov. 10, 2016 and was originally published on Jun. 30, 2016.
It's been a wild year for U.S. stock markets, with investors experiencing the worst start to a new year ever -- an 8% to 10% decline in major U.S. indexes over the first two weeks -- as well as the biggest intra-quarter rally in 83 years. During the summer, investors were dealt the "Brexit" blow, with Britain voting 51.9% to 48.1% to leave the European Union. The global stock market declines experienced the day following the Brexit vote wiped out $2.1 trillion in global wealth, and it led to the eighth-biggest point decline in the history of the Dow Jones Industrial Average, 610 points.
Gold and silver put on a show
But it's been an entirely different story for precious metals and the miners that produce these metals. Gold experienced its best single quarter in Q1 in 30 years, and both silver and gold have clearly moved into bull market territory.
There are a number of factors at work to explain why gold and silver are soaring.
To start with, gold (and silver, since it tends to follow gold's movements) are safe-haven investments. When there is domestic or global growth uncertainty, or market instability, investors tend to flock to precious metals, which are viewed as a long-term store of value.
Demand for both metals has also been on the rise. We often think about emotions driving spot metal prices, but supply and demand do play a role as well. According to a World Gold Council report released in May, gold demand surged 21% during the first quarter, which is its fastest pace on record. Demand for gold has come from central banks, businesses, and investors. Similarly, the Silver Institute projected earlier this year that silver demand for ethylene oxide and photovoltaics (i.e., solar panels) was expected to rise substantially.
11.7 trillion reasons gold and silver could head much higher
Yet there's an even bigger reason spot gold and silver are soaring and very well could continue to climb. Actually, it's more like 11.7 trillion reasons.
Based on the a Fitch Ratings report released on in June, $11.7 trillion worth of global debt is now trading in negative-yield territory, including $7.9 trillion from Japan alone. This is a 12.5% increase from just four weeks prior, per the data. Furthermore, Fitch Ratings' report also signals that bond buyers are willing to hold negative-yielding debt for even longer periods of time. Negative-yield debt with maturities of seven or more years totaled $2.6 trillion based on the report, which is almost double the amount from April.
What these negative yields imply is that investors are so worried about the global markets that they'd rather take guaranteed nominal losses by holding negative-rate debt than consider investing it in the stock market.
More importantly, the flight to negative-yield bonds further reduces the opportunity cost of owning gold or silver. Remember, physical metals don't pay a dividend, so if bonds are yielding 5%, as an example, and gold isn't yielding anything, investors would be giving up quite a bit of guaranteed interest to buy gold. However, if yields are negative, or the 10-year rates are, as we see now, under 1.4% in the U.K. or below 2% in the U.S., the opportunity cost of buying physical metals as opposed to bonds is relatively low. In fact, buying an interest-bearing asset below 2% could result in real-money losses, since the inflation rate has been closer to 2% since the Great Recession.
Long story short: The surge in negative-yield bonds could very well signal substantial upside still to come in physical gold and silver.
Mining stocks to consider
With this in mind, it's probably no surprise why gold and silver miners have essentially been the year's top-performing industries. But what mining stocks should you consider buying to take advantage of this surge in underlying metal prices? Here are a handful I'd encourage you to look into.
First, prospective mining investors should give serious consideration to gold and silver royalty stream companies such as Royal Gold (NASDAQ:RGLD) and Silver Wheaton (NYSE:SLW). Instead of traditional mining activities that involve mine build-out and maintenance, royalty stream operators work out long-term or life-of-mine supply contracts with mining companies in exchange for upfront cash that the mining companies use to expand existing mines or develop new mines. In return, companies such as Royal Gold and Silver Wheaton pay well below the market rate for delivered product and bank the difference between their payout rate and the current spot price.
For example, during the third quarter, Silver Wheaton announced that its silver cash costs were just $4.51 an ounce and gold was only $390 an ounce. This would imply that Silver Wheaton is banking around $14 an ounce for silver and more than $860 an ounce for gold, based on their current spot prices. In other words, the most immediate margin boost from rising metal prices is liable to felt by Royal Gold and Silver Wheaton, so they're also likely to be your best bet to receive a decent dividend.
Another suggestion would include precious-metal miners that have substantially lowered their mining costs (although the vast majority of the industry has) in recent years. Bigger isn't always better, but in the case of Barrick Gold (NYSE:ABX) we've witnessed a remarkable turnaround in just a few years.
After examining nearly a dozen of the largest gold miners in May, Barrick Gold stood out as the miner with the lowest all-in sustaining cost (AISC) projection this year, at a midpoint of $785 an ounce. Barrick has since lowered its AISC guidance even more, to a fresh range of $740 an ounce to $775 an ounce as of the end of the third quarter. Not only has Barrick been prudent with expanding only its highest-grade ore mines, but it's also been rapidly shrinking its debt. It repaid $3.1 billion worth of debt in 2015 and is targeting another $2 billion in 2016. Lower debt levels mean lower interest payments and more flexibility.
Finally, mining stocks that have a diversified portfolio of metals could be worth a look. The homer pick here, since I'm a shareholder, would be Silver Standard Resources (NASDAQ:SSRI).
Recently, Silver Standard scooped up Canadian-based Claude Resources in what amounted to nearly an all-stock deal. The acquisition gave Silver Standard access to the Seabee Mine and Santoy Gap, effectively boosting its annual gold production by about 70,000 to 75,000 ounces per year -- not to mention that Claude Resources had one of the lowest AISCs in the industry before being bought. This new gold stream helps balance out Silver Standard's previously silver-heavy production portfolio. Combined with lower-than-expected cash costs at Pirquitas and Marigold, Silver Standard Resources looks ready to take advantage of increases in gold or silver prices.
Is it time for you to dig into gold and silver miners in your portfolio?
Sean Williams owns shares of Silver Standard Resources, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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