Following a miserable fourth-quarter swoon, the stock market shone brightly in the first quarter. The broad-based S&P 500 wound up advancing by just over 13%, marking its best start to a new year since 1998. Better-than-expected corporate earnings, strong U.S. economic growth, and a temporary cessation of trade-war tariffs between the U.S. and China all provided the spark that eventually lifted the market to record highs.
But, if there's something you learn as a longtime investor, it's that there's always some event or statistical figure that can rain on the stock market's parade at a moment's notice. Right now, that worrisome figure is the precipitous decline in U.S. Treasury yields.
U.S. Treasury yields are plunging, which is an ominous sign for stocks
As of this past Wednesday, the closely watched 10-year Treasury yield, which plays a big role in helping to dictate where mortgage rates will head, hit a 20-month low of 2.21%, which is down 32 basis points from this time last month, and 57 basis points from the year-ago period. Since bond prices and bond yields move inversely to each other, it simply means that investors have been actively buying bonds since November, pushing the yield on the 10-year Treasury note down just over 100 basis points from an intraday high of 3.24% on Nov. 8, 2018.
What's the big deal if bond yields drop, you ask? The problem ties into risk.
Ideally, if the U.S. economy were viewed as strong, and corporate earnings were motoring along, we'd like to see investors selling bonds and putting their money to work in equities (i.e., the stock market). Although stocks offer considerably greater risk than Treasury bonds, the aggregate return over the long run is much higher with equities. The fact that we've witnessed a precipitous decline in bond yields since November, and therefore pretty significant bond-buying, suggests that Wall Street and big-money investors are very concerned about the stock market and aren't willing to risk their capital, despite the historically superior return of stocks relative to bonds.
Gold and silver stocks could soar if Treasury yields continue to sink
Interestingly enough, though, declining Treasury yields aren't all bad news for equity investors. In fact, these falling yields could light a spark under precious metals, setting the stage for a gold and silver stock rally.
To be clear, there are no shortage of factors that influence the spot price of gold. Everything from physical demand to intangible fear can influence the price of the yellow metal, and in turn pull silver along for the ride.
But what can arguably be described as the biggest factor in the ascent or decline of gold is U.S. Treasury yields -- the reason being that gold is a physical asset that doesn't have a yield. If you buy a gold ingot or bar, you're not going to receive a dividend, and you're certainly going to be exposed to downside risk if the spot price of gold declines. Meanwhile, Treasury bonds are backed by the full faith and credit of the U.S. government, meaning a bondholder is practically guaranteed to be paid the stated yield at purchase.
When bond yields are high or rising, more investors will choose to buy bonds over gold for their safety and certainty. But when Treasury yields fall, the return potential of gold becomes more attractive. This is especially true when T-bonds approach, or fall below, the 2% yield level. At this point, inflation tends to cancel out most (or all) of the nominal gains that bond buyers would generate in a given year from interest. That's pretty much where we're at right now. Investors could purchase a T-bond with the expectation of making virtually no real money, or take a possible, but nowhere near-guaranteed, cue from the bond market that turbulence could await the stock market and buy gold or silver stocks instead.
These gold and silver stocks could thrive
With the bond market flashing pretty clear warning signs to the equity market, two gold and silver stock miners that come to mind as particularly well positioned are small-caps SSR Mining (TSX:SSRM) and First Majestic Silver (NYSE:AG).
SSR Mining: A veritable steal among gold stocks
SSR Mining expects to generate about 80% of its revenue from the sale of gold in 2019, with the remainder coming from the sale of silver. However, this ratio could shift a bit in the coming quarters as the company's joint-venture Chinchillas project in South America, which is rich in silver, is brought up to full production capacity.
Aside from improving production diversity, there are two aspects of SSR Mining that allow it to stand out. First, there's been continued improvement in the company's two core gold-producing properties: Marigold and Seabee. The flagship Marigold facility in Nevada looks to increase annual production by 30% to roughly 265,000 ounces by 2021 or 2022. Even at this accelerated yield, Marigold still has about a decade of active mining ahead of it, as well as 15 years of production. As for Seabee, which was acquired in 2016 when SSR Mining bought Claude Resources, it's delivered record production with low sustaining costs every year since it was purchased. That record production is expected to continue this year, with between 95,000 and 110,000 gold ounces forecast by the company.
The other factor that stands out is SSR Mining's net cash position. Whereas most gold and silver mining stocks are noticeably in debt as a result of expansion projects, exploration, and/or acquisitions, SSR Mining's management team has remained prudent with its expansion and acquisition strategy. It ended the first quarter with $461.4 million in cash and cash equivalents, as well as $32.6 million in marketable securities, compared with $276.8 million in debt. That's $217.2 million in net cash for a profitable company with a $1.3 billion market cap. Tack on Wall Street projections of up to $2 in cash flow per share by 2021, and you have what I believe is a steal among gold stocks.
First Majestic Silver: Maximizing your exposure to silver
The other way to play a rise in precious metals is to consider buying the mining company most exposed to silver: First Majestic Silver. Overall, First Majestic will generate in the neighborhood of 62% of its revenue from silver, with another third of its sales coming from gold. The remainder derives from the sale of lead and zinc.
A combination of production improvements at existing mines, the development of soon-to-be commercial mines, and acquisitions have placed First Majestic Silver on a trajectory that should see record silver and silver equivalent ounce (SEO) production in 2019 and multiple years thereafter. This year, the company has guided for 14.2 million to 15.8 million silver ounces, and 24.7 million to 27.5 million SEO, which represents a rough doubling in SEO production since 2013.
Arguably the biggest boost for First Majestic's production potential comes from its 2018 acquisition of Primero Mining. Primero's core asset was the San Dimas silver and gold mine, which, in 2019, projects for between 5.5 million and 6.1 million silver ounces, and between 11.9 million SEO and 13.2 million SEO. Not only is this the leading producer of First Majestic's six operating mines, but it's the most efficient from a cost perspective, with all-in sustaining costs per SEO of $7.58 to $9.27.
Looking ahead, the company should be able to add what I figure is 2 million silver ounces each from Plomasas and La Luz once they're brought online over the next couple of years. This puts 35 million SEO within reach by perhaps 2022, which should dramatically boost operating cash flow. Assuming the silver-to-gold ratio narrows, implying that silver outperforms gold, First Majestic is best positioned to shine.