Yesterday, the Federal Reserve chose to raise its federal funds target rate for just the second time in a decade. The 25-basis-point increase was widely anticipated by Wall Street and moved the federal funds rate to 0.75%, which historically is still near an all-time low.
It's all about opportunity cost
Arguably, the industries that have taken the Fed's decision to increase interest rates the hardest are gold and silver miners. Here's just a snapshot of some of the downward moves witnessed today:
- First Majestic Silver Corp. (NYSE:AG): down as much as 12%
- Yamana Gold Inc. (NYSE:AUY): down as much as 11%
- Coeur Mining Inc. (NYSE:CDE): down as much as 10%
- Hecla Mining Company (NYSE:HL): down as much as 10%
- IAMGOLD Corp. (NYSE:IAG): down as much as 11%
- Golden Star Resources Ltd. (NYSEMKT:GSS): down as much as 12%
The main reason behind the weakness in gold and silver stocks can be traced to the transformation underway in the opportunity-cost argument as it pertains to gold and silver.
Opportunity cost is the act of giving up a near-guaranteed gain with one asset for the opportunity to earn a bigger gain with a different asset. Interest-based assets, such as a savings account, bank CD, or Treasury bond, have mostly been yielding less than the national rate of inflation. This means consumers have been earning nominal returns, but losing real money since their purchasing power is declining due to inflation.
However, when the Fed boosts interest rates, it also increases the yields on savings accounts, CDs, and Treasury bonds, making these interest-bearing assets more attractive to income-seeking investors who feign risk. The higher that yields go for interest-bearing assets, the more unlikely it is that investors will pass them over.
This last point is particularly important because neither physical gold nor silver pays a dividend. These are metals that investors typically buy out of uncertainty as a hedge against downside potential in the stock market, or because interest-bearing assets aren't worth owning because of their low yields. If the Fed sticks to its new game plan of three rate hikes in 2017 (up from a prior forecast of two), it could entice investors out of gold and silver and into bonds and CDs. This is why silver and gold, as well as the miners of these respective precious metals, are being crushed.
However, this shift in opportunity cost merely allows the real reason to own gold and silver miners to shine: their improving fundamentals.
To be perfectly clear, falling gold and silver prices aren't ideal, and investors are clearly going to have to deal with some volatility as the gold and silver markets come to grips with the prospect of three interest rate hikes expected in 2017 (albeit four were expected in 2016 and we received just one, so forecasts should be taken with a grain of salt). But gold and silver miners have generally done a very good job of reducing costs, cutting debt, and in many cases, boosting production at high-ore grade mines in order to remain profitable, even with gold at $1,130 per ounce.
Prudent spending and efficiency shines bright for these miners
For example, Coeur Mining, which predominantly mines silver, has been spending more now to save a lot more later. It's in the process of transitioning its operations from a mix of surface and underground operations to solely underground operations. The transition, once complete, should dramatically reduce Coeur's capital expenditures and lower its all-in sustaining costs (AISC). To boot, the company also repaid a $99-million term loan in July, reducing its annual interest expenses in the process and eliminating about 20% of its debt.
Golden Star Resources, which has its eyes focused on its Wasaa and Prestea mines in West Africa, has also worked to keep its costs under control. African miners are often at a disadvantage due to higher labor costs and the prospects of political instability, but Golden Star managed to deliver an all-in sustaining cost (AISC) from its two core mines of $1,153 per ounce in the third quarter, which is considerably lower than where its AISC stood a few years prior. More so, Golden Star, like Coeur Mining, is moving its Wasaa and Prestea operations underground where ore grades are higher and capital expenditures (capex) should be considerably lower once commercial production commences.
IAMGOLD, which has mines in West Africa, along with North and South America, has done well in controlling its costs while efficiently boosting production, too. The Essakane mine, located in Burkina Faso, generated a 17% sequential quarterly increase in gold production with a very sustainable AISC of $815 per ounce during the third quarter. Even more importantly, a $230-million equity-financing deal allowed IAMGOLD to repay 23% of its outstanding debt, which should give the company opportunities to focus on its organic growth.
Expansion is the name of the game for these gold and silver miners
Other miners, though, have taken a more free-spending approach in recent years. The following gold and silver miners could see their production explode higher in the years to come, all while their costs remain reasonably low.
For instance, Yamana Gold is looking organically and inorganically for production growth. Internally, it's developing its C1 Santa Luz, Cerro Moro, and Suruca development, which are expected to commence commercial production in 2018, 2018, and 2019, respectively.
C1 Santa Luz will be a really nice boost with 130,000 ounces of gold expected in its first full year of production, with an average of 114,000 ounces of gold expected as an average over the first seven years. Yamana also gobbled up the gold and copper Riacho dos Machados mine for less than $50 million earlier this year, and it looks poised to nearly double the mine's gold output to 100,000 ounces a year by 2018.
First Majestic Silver has also pleased its shareholders with a combination of increased production and lowered AISC. By-product costs at Santa Elena that led to negative cash costs per silver ounce helped push the company's AISC down to $10.52 per silver ounce, a 27% decrease from the prior-year period. All the while, higher ore grades, increased average silver prices, and an increase in tons processed and milled led to a 78% increase in revenue.
Last but not least, Hecla Mining delivered impressive Q3 results on Election Day that highlighted higher ore grades, improved production, and/or higher throughput in most of its mines. Lucky Friday in Idaho saw a 50% increase in silver production as a result of higher ore grades and throughput, while Casa Berardi in Quebec, Canada, generated 9% higher gold production due to higher ore throughput and mill recoveries.
Long story short, even with gold and silver prices losing their shine of late, gold and silver miners are considerably better prepared for a downturn than they were even two or three years ago. Even at today's spot prices, all of these miners, with the possible exception of Golden Star Resources, should remain healthfully profitable, and may therefore be worth a closer look by value-seeking investors.