Since the beginning of 2016, interest rates have been up, U.S. GDP growth has improved, and the unemployment rate has fallen. And yet, precious-metal mining stocks are among the top-performing industries, with many mining stocks having doubled, or perhaps tripled, from their 2016 lows.
Here's why precious-metal stocks are on fire
Why the excitement surrounding gold and silver stocks? Don't look to any one factor. Instead, it's a combination of aspects fueling the belief that precious metal spot prices are going to head higher.
For example, rising interest rates are usually bad news for physical gold and silver, because it increases the opportunity cost of owning precious metals. You see, neither gold nor silver offers investors a yield, whereas a U.S. Treasury bond does give a near-guaranteed return that's growing a bit larger with each interest rate hike from the Fed. A higher yield on Treasury notes is usually a recipe for precious-metal selling and bond buying.
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However, we're also seeing inflation on the rise, and higher inflation levels usually counteract the negative influence higher interest rates can have on gold and silver. As the economy expands, the Fed expands the money supply, thus diluting the value of each dollar in circulation and making it more expensive to buy an ounce of gold or silver.
In addition to inflation, uncertainty surrounding Trump's presidency and Britain's exit from the European Union are helping spot metal prices, as are constrained supplies of these metals. Considering the decline in gold and silver prices between 2011 and the end of 2015, many mining stocks sizably pared back on their capital expenditures, which meant less in the way of exploration and production. This lack of production growth alongside relatively steady demand growth has helped buoy precious-metal prices.
If this ratio is right, silver looks poised to outperform gold
But of the two most popular investable metals, gold and silver, it's silver that could get the most attention thanks to the gold-to-silver ratio (i.e., how many ounces of silver it would take to buy one ounce of gold). Throughout the previous century, the gold-to-silver ratio hovered around 50. If it fell below this average, gold was deemed the more attractive investment opportunity. Conversely, if it was well above 50, silver was the appropriate choice of long-term investors. Based on spot prices today, the gold-to-silver ratio is at nearly 73-to-1, signaling that silver appears primed to outperform gold.
Which silver stocks should investors be focusing on? How about those that are cheapest based on future cash flow per share.
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Why future cash flow per share, you wonder? To begin with, cash flow is important to all businesses, especially mining companies, since positive cash flow is what allows mining companies to reinvest in their business via exploration and mine expansion. Cash flow is also often responsible for the capital needed to make acquisitions, as well as pay shareholders a dividend. In simple terms, the more cash flow a company produces, the more financial flexibility it probably has. And the cheaper a company trades relative to its annual cash flow projections on a forward basis, the more undervalued it may be.
These silver stocks appear fairly valued
Though you won't find historical data on the silver industry's price to cash flow per share (P/CFPS), as an avid follower of mining stocks for a long time, I can tell you that a forward ratio of roughly 10 is right around fair valuation. This also happens to be where a number of silver mining stocks are currently valued. Endeavour Silver, Silver Standard Resources, Pan American Silver, and Hecla Mining are all within 5% of a P/CFPS of 10.
The one exception to the upside is Wheaton Precious Metals (NYSE: WPM), which is valued at 14.7 times its forward CFPS. However, that doesn't necessarily make Wheaton Precious Metals an expensive stock. Unlike the silver miners above that operate as traditional mining companies, Wheaton is a royalty and streaming company that provides large sums of up-front capital to mining companies in exchange for a percentage of production at a well-below spot price for a long period of time. Since Wheaton has the highest margins in the silver industry by a mile, it seemingly deserves the premium bestowed upon it.
These silver stocks are cheap relative to their future cash flow per share
If you want the cheapest silver mining stocks right now based on future CFPS, look no further than Coeur Mining (CDE 9.50%), Fortuna Silver Mines (FSM 3.94%), and First Majestic Silver (AG 7.03%).
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The cheapest of all is Coeur Mining, which is valued at just 6.4 times Wall Street's projects CFPS in 2018. Then again, Coeur has also had among the highest all-in sustaining costs (AISC) in the industry, so that could very well be why it's been priced at a discount by Wall Street relative to its peers. The reason its AISC is so high is that it's been moving its operations from a mix of open-pit and underground mining to purely underground mining. While the initial costs are hefty for such a move, the ore grade and yield of such a transformation should be much higher for the company, leading to lower long-term costs and improved production.
All the while, the company's Palmarejo mine in Mexico and Wharf mine in South Dakota continue to demonstrate much-improved production, leading me to believe that long-term investors in Coeur Mining will indeed be rewarded.
Fortuna Silver Mines is a pretty close second, with a price to future CFPS of just 7.1. What makes its valuation even more impressive is that it's only presently working with two producing mines, and is in the midst of a notable expansion. During the first quarter, Fortuna reported that its flagship San Jose mine in Mexico milled 3,108 tons a day, which was a 51% improvement over the prior-year period. This was due to the completion of a plant expansion at San Jose. Its other operating mine, Caylloma in Peru, saw a more modest expansion in average milling per day, albeit grade and recovery were much lower in the first quarter.
Fortuna really has a shot to come into its own with the Lindero gold project in Argentina. It's common these days for silver miners to spread their wings into gold and other metals as opposed to being wholly reliant on silver. The company announced that it has the capital to move forward with the Lindero project, which will be discussed more during the third quarter. With gold, zinc, and lead acting as byproducts to offset its silver mining costs, Fortuna may continue to have one of the lowest AISCs in the industry.
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Finally, First Majestic Silver is valued at a future CFPS of 9, placing it at less of a discount than Coeur or Fortuna, but a slightly larger discount than the remainder of its peers. What makes First Majestic so intriguing is that its production portfolio is more tied to silver than any other silver miner. As noted above, most silver miners have diversified their production portfolios to include gold or other base metals. First Majestic still depends on silver for about 70% of its revenue. Comparatively, Silver Standard Resources will likely generate less than 20% of its revenue from silver this year. If silver is to outperform gold, First Majestic would see more in the way of benefits than its peers.
Best of all, First Majestic hopes to bring a number of silver-heavy projects online in the coming two to four years. The Plomosas and La Luz projects could generate in the realm of 2 million silver equivalent ounces of production within four years. Meanwhile, growth at La Encantada and steady production at its other core mines may yield as much as 20 million silver ounces produced by 2020 or 2021. This would represent nearly 70% growth from the 11.9 million silver ounces produced in 2016.
If you're looking for cheap silver stocks, I'd suggest digging into Coeur Mining, Fortuna Silver Mines, and First Majestic Silver.
