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XMFSinchiruna (27.48)

Prepare for a Golden Earnings Bonanza

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July 12, 2010 – Comments (7) | RELATED TICKERS: CDE , GG , AUY

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

Excerpts:

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.

http://www.fool.com/investing/small-cap/2010/07/08/taseko-mines-through-adversity-to-prosperity.aspx

 

7 Comments – Post Your Own

#1) On July 12, 2010 at 5:07 PM, XMFSinchiruna (27.48) wrote:

Some debt-related thoughts I just posted to another blog

Absolutely right, Andrew. Not to mention the extent to which unpalatable economic realities will erode the political expediency of austerity rhetoric faster than we can say global quantitative easing.

And what of the insolvent states and municipalities here at home? That zoo full of 800-pound gorillas already has further trillions in bailout dollars with its name on it. 

From Obama's debt and deficit commission:

The commission leaders said that, at present, federal revenue is fully consumed by three programs: Social Security, Medicare and Medicaid. "The rest of the federal government, including fighting two wars, homeland security, education, art, culture, you name it, veterans — the whole rest of the discretionary budget is being financed by China and other countries," Simpson said.

 

The US turned 234 years old yesterday, and yet over half of the nation’s money supply was created since Helicopter Ben took over the flight controls four years ago. No wonder gold is in a full-fledged bull market.
– David A. Rosenberg, Chief Economist & Strategist, Gluskin Sheff & Associates Inc.

 

http://www.washingtontimes.com/news/2010/jul/7/us-marks-3rd-largest-single-day-debt-boost/

The nation's debt leapt $166 billion in a single day last week, the third-largest increase in U.S. history, and it comes at a time when Congress is balking over higher spending and debt has become a key policy battleground.

The one-day increase for June 30 totaled $165,931,038,264.30 - bigger than the entire annual deficit for fiscal year 2007 and larger than the $140 billion in savings the new health care bill will produce over its first 10 years. The figure works out to nearly $1,500 for every U.S. household, or more than 10 times the median daily household income.

Daily debt calculations jump and fall, and big shifts are common. But all three of the biggest one-day debt increases have occurred under the tenure of President Obama, and all of the top six have been in the past two years - an indication of just how quickly the pace of deficit spending has risen under Mr. Obama and President George W. Bush.


On Wednesday, the Congressional Budget Office said the government has recorded a $1 trillion deficit for the first nine months of fiscal 2010, which began Oct. 1. That's slightly down from 2009's record $1.1 trillion deficit at this point.

 

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#2) On July 12, 2010 at 5:52 PM, MegaEurope (21.53) wrote:

"I expect the profitability reported by precious-metals miners over the next several weeks to be nothing short of spectacular."

And by spectacular, you mean what exactly?  You don't give any hard examples of earnings estimates that will either prove your article right or wrong.

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#3) On July 12, 2010 at 6:39 PM, XMFSinchiruna (27.48) wrote:

MegaEurope

I don't let myself get wrapped up in the game of guessing EPS. Despite all the hype, it's never anything more than a barely educated guess. As you will no doubt concede, even highly paid professional analysts from the top brokerage houses have a hilariously poor track record of forecasting EPS with any semblance of accuracy.

With gold and silver prices solidly above where they were last quarter, and costs trending lower on average, the stage is set for the strongest earnings result for the sector that we have seen thus far in the 10-year bull market cycle.

You'll know what spectacular earnings results look like when you see them. You won't have to wait long. :) They are particularly recognizeable when they trigger a sector-wide re-pricing of shares (higher, of course), which I am predicting we will see even if gold and silver prices remain range-bound through the releases.

There is, in general, I believe, a tepid view towards miner profitability baked into present gold and silver mining share prices. As cash flow reaches critical mass, and miners begin to initiate or raise dividends en masse, that profit potential will no longer go undervalued. I am trying to alert investors that these sorts of revaluations are on the near and medium-term horizon as metal price advances continue to occur in the absence of the acute cost pressures we witnessed during previous chapters of the bull market.

 

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#4) On July 13, 2010 at 1:25 AM, DarthMaul09 (29.72) wrote:

I did take that leap of faith and bought more TGB at $3.42 following the recent sell off.  Not even considering the relatively high gold price and reasonable oil price this last quarter, the financial numbers available on Google Finance for TGB seemed almost too good to be true, which did not include the potential of the Prosperity mining project.  In spite of my recent CAPS recovery, my mining picks have not helped me yet, but unlike a Harry Potter movie, I hope to see those Gryffindor colors turn to Slytherin green.

 

uclayoda87 (30.26) Submitted: 4/24/2010 7:40:01 AM : Start Price: $5.87 TGB Score: -19.65

The recent pull back on TGB was probably the last significant buying opportunity for investors who wanted to take a position in this company. It appears that rumors of a recovery will be driving the markets higher in the near term, which will help commodity producers. TGB appears to be making steady progress towards its production expansion. Once this has been achieved, the stock price would likely be much higher than it is today and it would resemble FCX with its growing dividend and excellent financial numbers.

1 Comment DarthMaul09 (98.37) Submitted: 7/4/2010 4:07:23 PM Recs: 3

I have been a bit concerned about TGB falling stock price, especially because of the weakness in the price of copper and the report noted on 100ozRound's recent blog post. But after thinking about this, I agree with TMFSinchiruna that the new project will eventually be approved and that investors are not looking at the profits that TGB is already making.

From Google Finance:
Key stats and ratios
   Q1 (Mar '10)    2009
Net profit margin    101.25%    5.59%
Operating margin    18.95%    5.96%
EBITD margin    -    6.64%
Return on average assets    53.74%    2.08%
Return on average equity    97.06%    3.60%

I will probably add to my position this week, since I really believe that TGB will be the next TCK.

 

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#5) On July 13, 2010 at 1:58 PM, silverminer (31.30) wrote:

DarthMaul,

Great call on the TGB! You're already up $0.83/share as of today. The major difference between TCK and TGB, though, is that TCK had to move all that way just to get back to where it was trading before it slammed into a debt crisis. TGB will be accelerating into fresh and (almost) uncharted territory. [Looking way back on the timeline, TGB traded at $13 in 1994!]. I'll have to go back and look at the history, but I don't think they even acquired Gibraltar until 1999.

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#6) On July 13, 2010 at 9:19 PM, Speed03 (< 20) wrote:

TMFSinchiruna

Can I get your opinion Eldorado Gold Corp (EGO)?

Cheers,

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#7) On August 29, 2010 at 3:07 PM, MegaMicrocap (< 20) wrote:

You'll know what spectacular earnings results look like when you see them.

Considering my lack of expertise in mining stocks, it's pretty doubtful I will.

Have they been spectacular so far? Which miners in particular have turned in huge quarters?

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