With enormous stakes resting upon the shoulders of second-quarter earnings results to telegraph the broad direction of the global economy, you can sense the tension in the air.
For those who have sought refuge from turmoil in the miners of gold and silver, however, the outlook for these particular earnings results could hardly be clearer. I expect the profitability reported by precious-metals miners over the next several weeks to be nothing short of spectacular.
Gold spent the entire second quarter north of $1,100 per ounce, while the average realized gold price for (unhedged) miners will likely be closer to $1,200 per ounce. The long-awaited margin expansion for low-cost gold miners has finally arrived in earnest, and I anticipate a rising tide of awareness regarding the alluring profit potential of quality miners.
The oil equation
Now that erroneous presumptions about the extent of correlation between the prices of gold and oil have lost their allure, we find in oil's range-bound trading a key element of the miners' enhanced profitability. Whereas the price of gold has sustained its upward momentum, oil has not. Although geological factors like ore grades, depth, and byproduct concentrations form the nucleus of a mine's underlying cost structure, energy-related inputs account for a major share of cost variability.
Because this topic is too often oversimplified to portray energy as the only meaningful variant, I hasten to remind Fools that a symphony of complex factors plays perpetually in the background. Before metal prices plummeted in the spring of 2008, for example, the impact of skyrocketing oil prices was exacerbated by an acute global shortage of those gargantuan tires that keep monster mining trucks moving. All the same, oil's important enough to the cost equation for Fools to anticipate expanding profit margins whenever oil fails to keep pace with metal prices over time.
The reigning kings of margin
Let's take a peek at this unfolding trend by examining one of the worst-performing names in the sector. Yamana Gold
Yamana reported an industry-leading production cost of just $161 per gold-equivalent ounce (GEO) in the first quarter, and foretold of still lower costs to come as 2010 unfolds (plus higher production volumes to boot!). Selling its gold for an average of $1,114 in the period, Yamana experienced a 67% surge in gross margin, to yield $842 for every ounce produced. Plugging in a realized gold price near $1,200, and costs trending lower still, we discover a margin expansion on increasing volumes that not even Yamana's unproven management could fail to convert to meaningful cash flow.
Major producer Newmont Mining
Although silver, incredibly, has yet to break through the $20 barrier last breached in March of 2008, I anticipate a similar margin expansion for silver miners as second-quarter earnings emerge. With its highly stable cost structure, I expect Silver Wheaton
Three more stocks to watch
When margin expansion opens a new chapter of profitability for an entire sector, I find the greatest investment prospects among operators who may have fallen out of favor with investors for reasons that are no longer at issue.
Coeur d'Alene Mines
Turning our gaze back to gold, I encourage Fools to take a close look at IAMGOLD
I have selected all seven of the aforementioned precious-metal producers as outperform picks within my silverminer CAPS portfolio. I invite each of you to pore over my picks and consider adding some to your own CAPS portfolio.
Fool contributor Christopher Barker carries a silver coin that reads: "Honest value never fails." He can be found blogging actively and acting Foolishly in the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Coeur d'Alene Mines, IAMGOLD, Northgate Minerals, Silver Wheaton, and Yamana Gold. The Motley Fool's disclosure policy is 0.999 pure.