Gold and Silver Stocks Are Being Routed. Is Now the Time to Buy?

By Markets

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Nothing goes up in a straight line, which is what precious-metal investors are finding out on Tuesday.

As of 2:30 p.m. EDT, physical gold was down $39 an ounce to $1,272, its lowest level since the date of the Brexit vote. By a similar token, silver, which tends to be more volatile than gold since it's more thinly traded, was down $0.93 an ounce, or 4.9%, to $17.86. This, too, represents a low point for physical silver since late June.

Some of the most-followed mining names, big and small, are feeling the pain:

  • Silver Wheaton (NYSE: SLW), down as much as 10%
  • Yamana Gold (NYSE: AUY), down as much as 11%
  • AngloGold Ashanti (NYSE: AU), down as much as 10%
  • Kinross Gold (NYSE: KGC), down as much as 12%
  • Pan American Silver (NASDAQ: PAAS), down as much as 13%
  • Coeur Mining (NYSE: CDE), down as much as 11%
  • Great Panther Silver (NYSEMKT: GPL), down as much as 10%

Why gold and silver are being routed

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What's leading to the rout in metal prices? It's actually a confluence of factors.

For starters, uncertainty usually helps gold and silver prices, but interest rate uncertainty does not. Gold and silver investors like to have clear-cut scenarios of what might happen with interest rates and upcoming Federal Open Market Committee meetings, but there's clear uncertainty as to whether or not the Fed could raise interest rates in December. Remember, higher interest rates should push the price of interest-based assets, such as bonds and CDs, higher, which increases the opportunity cost of forgoing those assets when buying physical gold or silver, which have no yield.

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Second, U.S. economic data simply hasn't been as bad as expected recently, which strengthens the case that the Federal Reserve could make a move on interest rates before the end of the year.

Third, gold and silver investors were looking for catastrophe with regard to Deutsche Bank'spotential liquidity and business woes following a $14 billion fine from the U.S. Justice Department to settle multiple investigations related to mortgage securities. Though there have been moments of panic surrounding Deutsche Bank, one of Germany's largest banks, its liquidity for the time being isn't as much of a concern as anticipated.

Finally, physical gold and silver simply haven't had a real correction since beginning their ascents earlier this year. Corrections are a healthy part of the investing cycle, so we could be witnessing some traders stepping to the sidelines as that correction takes place.

The big question, though, is whether or not this rout in physical metals is a buying opportunity for investors? My suspicion is that it is.

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Gold and silver have numerous catalysts

The most important factor that investors have to keep in mind is that the opportunity cost trade-off between buying interest-based assets and precious metals still favors precious metals, even if the Fed decides to act in December. Lending rates have been kept near historic lows for almost eight years, and boosting the federal funds target rate up to 0.75% would still put most interest-bearing assets on track to underperform the inflation rate, thus resulting in real money losses. Until we see notably higher yields on bonds or CDs, gold and silver should remain an intriguing investment opportunity.

Also, the fundamental supply-and-demand picture for gold and silver remains strong. Investors often overlook that supply and demand do matter when it comes to physical metal prices. In the case of gold, the World Gold Council pointed out in August that first-half demand in 2016 was up 15% to 2,335 tons compared to just a 1% increase in supply. Rapidly growing demand and constrained supply is usually a recipe for higher prices. Similar forecasts have called for modest growth in silver demand this year from investors and the solar industry, since silver is an excellent conductor of electricity and heat.

Third, there are still enough uncertainties in the marketplace that you could cut through them with a knife. Perhaps the biggest uncertainty is the upcoming U.S. election. Beyond the U.S. election, Brexit remains in focus, as does a slowing Chinese economy and stagnant growth throughout much of Europe. Physical gold and silver could certainly remain a safe-haven investment for the foreseeable future.

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These are fundamentally sound mining companies

However, the most telling reason why today's rout could be a buying opportunity has to do with the much-improved fundamentals behind precious-metal stocks. Of the seven gold and silver miners listed above, each is delivering remarkably better results due to expanding production, mergers and acquisitions, reduced costs, or some combination of the three. Let's take a brief look.

  • Silver Wheaton: Unlike the rest of the miners on this list, Silver Wheaton is a royalty and streaming company. This means Silver Wheaton provides upfront capital to facilitate the expansion or development of existing mines in return for a certain amount of production in return at prices that are often well below spot. Furthermore, these contracts tend to be for the long term or for the life of the mine. During the second quarter, Silver Wheaton took delivery of gold and silver at average per-ounce prices of $401 and $4.46, respectively. Even with today's tumble in physical metal prices, Silver Wheaton has an $870 per-ounce gross margin in gold, and a more than $13 per-ounce margin in silver.
  • Image source: Kinross Gold.

    Yamana Gold: On the other hand, Yamana Gold actually witnessed its all-in sustaining costs (AISC) rise by 12% during the second quarter, which is the opposite direction of most of its peers. The reason for the increase in AISC was a good one, though, as it's advancing the Cerro Moro and C1 Santa Luz mines for commercial production by 2018. Yamana also acquired the Riacho dos Machados mine from Carpathian Gold earlier this year. This mine could wind up adding 100,000 ounces of gold production annually by as early as next year. Yamana has taken advantage of this year's upturn in physical gold to go shopping.

  • AngloGold Ashanti: African gold miner AngloGold Ashanti has benefited by keeping costs under control. In the second quarter it wound up reducing its AISC by $13 an ounce from the prior-year period to $911 an ounce, while more importantly reducing net debt by 32% to $2.1 billion, including its highest-interest loan. Lower debt levels mean less in interest payments, which should further lower its costs.
  • Kinross Gold: If investors want a cheap gold miner, look no further than Kinross Gold, which is the cheapest of the large gold miners based on future cash flow per share. Things haven't always been pretty for Kinross, which vastly overpaid for Red Back Mining and its Tasiast Mine in 2010, but its acquisition of Tasiast may finally start paying dividends. A $728 million investment to expand milling capacity to 12,000 tons per day from 8,000 tons should boost production at the mine by 87% and cut cash costs at the mine by close to half. Long-term debt is also down at Kinross, making for an intriguing investment opportunity.
  • Image source: Kinross Gold.

    Pan American Silver: Among silver miners, Pan American Silver has been focused heavily on improving quality of production over quantity. During the second quarter, Pan American Silver reported a 41% decline in cash costs per silver ounce and $66 million in operating cash flow, representing its highest level since the fourth quarter of 2012. Meanwhile, Pan American is also working to expand its La Colorada and Dolores mines, which should yield improved production results and higher operating margins beginning in 2018.

  • Coeur Mining: Like Yamana Gold, Coeur Mining has been all about expansion these past couple of quarters. Second-quarter silver equivalent ounce production soared 19% to 9.6 million ounces, which is pretty incredible considering that its AISC actually fell 4% on a year-over-year basis. Significant expansion at its Palmarejo mine is expected to generate a big bump in cash flow moving forward, which in turn is expected to allow Coeur Mining to ramp up development of a few early stage projects in the U.S. and Mexico.
  • Great Panther Silver: Finally, small-cap silver miner Great Panther Silver has been focusing its efforts on cost-cutting as it prepares to ramp up its capital expenditures. During the second quarter, Great Panther Silver announced a 74% decline in year-over-year cash costs and 43% tumble in year-over-year AISC. If Great Panther can stick to its AISC forecast, which is still well below the spot price for silver at the midpoint, it should be nicely cash flow positive and perhaps even profitable.

In many respects, gold and silver miners could have been considered value stocks based on traditional fundamental measures before today's tumble. Following the rout, many of these companies look downright attractive, and I'd certainly encourage precious-metal investors to dig a bit deeper into these miners.

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Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.

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