Up until August, precious metals like gold and silver were the stars of 2016. In many instances, you could have thrown a dart and picked a gold or silver miner that had at least doubled in value this year. Then the wheels fell off the wagon.
The Federal Reserve reverted to its hawkish view on interest rates, culminating in a 25-basis-point increase earlier this month, and U.S. economic data continued to improve, pushing the U.S. dollar higher. All of this is bad news for gold and silver, both of which have been hit especially hard since the election.
Why gold and silver are surging
Today, however, is a different story. Physical gold is up by better than 1% -- about $13 per ounce -- to $1,155, and spot silver is up almost 1%, at $16.11 per ounce. Not surprisingly, the underlying mining companies that produce these precious metals are up even more:
- Silver Wheaton (NYSE:SLW): up as much as 10%
- Endeavour Silver (NYSE:EXK): up as much as 13%
- First Majestic Silver (NYSE:AG): up as much as 11%
- B2Gold (NYSEMKT:BTG): up as much as 12%
- Alamos Gold (NYSE:AGI): up as much as 12%
What are the catalysts behind today's surge higher in gold and silver prices? It appears to be a combination of two factors.
First, we probably have a carryover effect from yesterday's disappointing release of pending home sales. Contracts to buy previously owned homes in the U.S. fell to a 10-month low according to data released on Wednesday. It's possible that higher mortgage rates and/or a tightening in consumer budgets could be to blame.
Regardless, though, gold and silver thrive when there's uncertainty, and the housing market has been one of the bull market's biggest catalysts in recent years. If the housing market begins to cool, gold and silver could regain some of their luster.
The other factor at play here is probably some simple profit-taking by investors. The U.S. dollar rallied to hit its highest level in 14 years during December on the heels of the strongest quarter of Gross Domestic Product (GDP) growth in two years. Furthermore, the 10-year Treasury note rallied more than 80 basis points in a month-and-a-half.
Today, the dollar is down, and so are bond yields, presumably as a result of the aforementioned weaker economic data, but also because of end-of-year profit-taking. Falling bond yields can make gold and silver especially attractive since it lowers the opportunity cost of owning the precious metals, which have no yield.
Can this precious-metal rally continue?
The big question is whether this relief rally in gold and silver can continue, or if it's fleeting. My suspicion is that gold and silver have a better chance of being lustrous in 2017 than tarnished.
There are two major wild cards in 2017 that'll probably favor physical gold and silver. First, the Federal Reserve is somewhat of an "X factor." Entering 2016, the consensus was the Fed would raise interest rates four times, by 25 basis points. By year's end, the Fed moved just once, and by only 25 basis points. The fewer times the Fed moves, the more attractive gold and silver could remain, since yields on interest-bearing assets would also remain relatively low.
There are numerous external catalysts that could cause the Fed to remain wary of rate hikes, including Brexit in Europe, and GDP growth weakness in China. There's also the possibility that a spoiled U.S consumer reacts poorly to interest-rate hikes, and GDP growth slows to a crawl. All these scenarios could potentially favor precious metals.
The other true wild card is the incoming Trump administration. Even though Trump has laid out an action plan to grow the U.S. economy, and Republicans have a majority in the legislative branch of government, there are no guarantees that Trump will be able to pass his policies into law. Nor is there a guarantee that his policies would generate 3%+ GDP growth, as advertised. If Trump slips up in the slightest as president, gold and silver would be the expected beneficiaries.
Of course, the top catalyst for gold and silver stocks in 2017 just might be their improved fundamentals.
Gold and silver stocks are in value territory
Until 2016, physical gold and silver both had been mired in multi-year downtrends. Consistently lower spot prices coerced mining companies to rein in their spending and focus on only their highest ore-grade projects. The result, as we're beginning to see based on recent quarterly filings, is lower all-in sustaining costs (AISC) and improved margins. In many cases, even with gold and silver more than $200 per ounce and $5 per ounce off their intraday highs for 2016, these mining companies can remain healthfully profitable.
Silver Wheaton is naturally in a class of its own because it's a royalty/streaming company rather than a traditional miner. Silver Wheaton provides large sums of cash upfront to mining companies looking to develop or expand a mine. In exchange, Silver Wheaton receives a long term of life-of-mine contract that promises delivery of a defined percentage of gold, silver, or other by-product metal at a well-below-cost rate.
During the third quarter, Silver Wheaton reported cash delivery costs of just $390 per ounce for gold and $4.51 per ounce for silver. In other words, precious-metal prices would have to veritably collapse for Silver Wheaton to no longer be profitable. Furthermore, not having to deal with the daily rigors of overhead mining costs means Silver Wheaton's margins are unmatched. It remains one of the strongest mining stocks to consider owning.
The remaining gold and silver miners that surged higher today also have a similar story to tell on the production and cost front.
Endeavour Silver managed to lower its AISC during the third quarter by 24%, and it's on pace to produce at a silver equivalent ounce (SEO) AISC of $12.50 at the midpoint in 2016. Even though production has been down year over year, the company is working smarter by focusing on its higher-yield mines, and it has six exploratory projects ongoing at the moment that should help expand its resource base. Even with silver at $16 per ounce, Endeavour can remain healthfully profitable.
First Majestic Silver offers even better full-year AISC guidance than Endeavour of $11.93 per SEO at the midpoint. First Majestic's Q3 report featured a 20% increase in silver production, to 3.1 million ounces, a new quarterly record. Renegotiated smelting and refining contracts have helped lower costs, but by-products at its flagship Santa Elena mine have really done a remarkable job keeping its SEO AISC down. Even after today's rally, First Majestic is valued at only nine times Wall Street's cash flow per-share estimate for 2017.
B2Gold, which primarily operates mines in West Africa and South America, reported a ridiculously low $702 consolidated AISC during the third quarter, which was 20% below what it reported in the prior-year quarter. B2Gold has managed to lower its AISC estimates for both its Masbate mine and Otjikoto mine this year, yet it also managed to boost production forecasts at Masbate by 25,000 ounces of gold at the midpoint, to 205,000 ounces. When combined with the Fekola mine, which should commence production in Q4 2017, B2Gold remains quite the value at nine times its future cash flow per share.
Finally, Alamos Gold, which is a smaller gold miner with only three mines in operation, managed to push its AISC below $1,000, to $979 per ounce, in Q3 2016. That's well below the $1,155 in AISC reported in Q3 2015. More impressive is that production at Young-Davidson and Mulatos have both increased by roughly 10,000 ounces of gold through the first nine months of the year, all while costs have fallen. With exploration at La Yaqui doubling the potential resources Alamos may be able to tap in the future, and Alamos trading at just 10 times Wall Street's estimated cash flow per share in 2017, it, too, looks attractive.
From the macro story to the improved fundamentals in these five gold and silver stocks, the industry could be ripe for value investors.
Sean Williams owns shares of Silver Wheaton, 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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