Prepare for a Golden Earnings Bonanza
A little sneak peek for curious Fools into the looming typhoon of skeptic-lashing profitability from the suite of precious metal miners.
Prepare for a Golden Earnings Bonanza
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.
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.
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.
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 (NYSE: SLW) to enjoy a cash margin above $14 per ounce for the second quarter, applied to rising sales volumes. This time last year, the price of silver itself languished below $14. What a difference a year can make!
Coeur d'Alene Mines (NYSE: CDE) provides a prime example. This stock became the favorite whipping post of disenchanted silver investors when construction delays and an oversized debt burden brought the company to the darkest hours of its 82-year history. In just over one year, however, the Kensington gold mine in Alaska has transitioned rapidly from an uncertain legal limbo into successful and timely inauguration. Production costs at Coeur's Palmarejo mine continue to decline as volumes improve, and are expected to reach just $2.50 per ounce of silver from a first-quarter mark of $5.41. All told, the company expects to produce more than 17 million ounces of silver in 2010 ... not to mention 170,000 ounces of gold. With a turnaround story that coincides beautifully with the sector's long-awaited margin expansion, and a share price that I consider massively undervalued, I consider Coeur d'Alene Mines among the top potential growth stories of the next few years.
outoffocus made an interesting comment about miners' tendancy to mindlessly track metal prices with little apparent regard for other factors. Here was my reply:
You have been involved long enough to notice one of the core inadequacies of investor behavior in their collective efforts to value mining shares. By responding to every blip in metal prices, many investors permit themselves to become far too focused upon short-term gyrations rather than longer term trends like this ongoing trend toward expanding operating margins.
Mining shares are certainly impacted by earnings results just as in any other sector, but in between they trade with a volatility that is in large measure fundamentally unjustified. Unfortunately, that volatility plays into the hands of professional traders who prey upon the weaker hands of the long interest at will.
Fortunately, the sector enjoys another regular source of major stock movements aside from metal prices and earnings results: the positive impact of new or expanded deposits identified through exploration. The potential for many of the top quality miners to effectively replace production over time is one factor that I believe remains often overlooked with respect to valuing these companies. Goldcorp is a perfect example ... often viewed as overvalued (and to some extent it is relative to its peers on strict comparative metrics), but the enormous brownfield exploration potential of Goldcorp's existing properties places such an apparent premium to reserves within the proper context.
This sector's wild swings from day to day are mere noise within the broader trend. As earnings reach a critical threshold that makes them impossible to ignore, I believe that mining shares will become less susceptible to some of that needless volatility. The trick is to have those "weak longs" grow more confident in the lasting bargain of their respective cost basis.
Also, I'm not sure if I already posted this, but here is my piece from last week on Taseko's permitting saga.