These days, as the broad averages are hitting new all-time highs, it can be difficult to find stocks well below recent peaks. In this regard, the precious metals industry stands out, if that’s the right way to put it. The members of our precious metals group have delivered a median minus 44% total return so far in 2013, and that includes dividends paid by all but two stocks. Thus, they have well above-average long-term appreciation potential of around 100%. The basic reason is no secret: gold and silver prices have fallen over one-third from their highs of two years ago.
The precious metals industry consists largely of gold stocks, with three that concentrate on silver and one closed end mutual fund. Production rises slowly in this group, and large new discoveries are quite rare. Demand for precious metals from industry and jewelry makers grows slowly, so overall demand depends to a great extent on investors’ need for safe havens in turbulent times such as the last five years. It was largely investment demand for gold that pushed the yellow metal to around $1,900 an ounce in 2011, and bullion selling by gold-holding exchange traded funds has returned gold to around $1,250 an ounce now.
While investment demand for precious metals is down, prices ought to get some support from other sources over the next year. Gold prices should benefit from Chinese and Indian demand as those huge countries develop. Moreover, national treasuries will probably buy more gold than in the recent past. Demand for silver is more weighted toward industry, and the growing world economy should help there. Finally, gold is just a bit above the average industry all-in cost estimate of around $1,100-$1,200 an ounce. In response to the price selloff, companies have reduced exploration outlays and are paring high-cost production. That should depress both gold and silver output in 2014 and lead to some price relief, even if investors do not again perceive a need for a safe haven from inflation and depreciating fiat money, which we believe is unlikely at this point.
Rather than filter our entire universe for stocks, this time, we only screen the precious metals industry for stocks with price appreciation potential above 90% and dividend yield above 2.0%. The stocks that made the cut can be seen in the list below. Of these, we have chosen to highlight Goldcorp (GG) and Pan American Silver (PAAS).
Goldcorp produces gold, silver, and base metals from 11 wholly and partially owned mines in Canada, the United States, Mexico, Argentina, Guatemala, and the Dominican Republic. A strong point for the company is that most of its production is in stable countries. The stock is at its 52-week low, 50% off its high, where it is yielding around 2.8%. As earnings cover the dividend, we do not anticipate a cut in the near future. Its long-term debt-to-capital ratio is a rock-bottom 3%
Third-quarter results came in right at our forecast, though 53% below the prior-year figure. Earnings suffered from lower metals prices, but the company achieved cost reductions at most mines. Management reaffirmed guidance of a 10% gold production increase in 2013, though it reduced its forecast for 2014, due to a delay in opening a new mine in Argentina. Nonetheless, gold output will probably increase by around 60% from 2012 to 2016, all from presently owned properties. We anticipate 3- to 5-year annual total return of around 20%, with price appreciation potential of about 100%.
Pan American Silver
Pan American Silver produces silver, gold, and base metals from eight mines in Peru, Mexico, Bolivia, and Argentina. It also sells silver and base metals in dore (low purity) and concentrate form. Output has grown rapidly in the last few years as new mines came on stream. At its recent price, down about 50% from the 12-month high, the stock yields around 4.90%. We forecast price appreciation potential of about 110%, and annual total-return potential of 23%.
Third-quarter results of $0.08 a share were down over 60%, thanks to low metals prices, but the September period report also held good news. The company’s all-in sustaining cost of silver came in at 16.26 an ounce, versus $24.27 an ounce in the 2013 June quarter, thanks to higher output and cost savings. Following recent rapid growth, output will probably rise at 5%-8% over the next few years. The company’s solid financial position makes a dividend reduction highly unlikely, in our judgment. Long-term debt of $63 million is just 3% of total capital, and the company has over $400 million of cash, some of which it is presently devoting to share repurchases.
|ASAGold & Precious
|Pan Amer. Silver
At the time of this article’s writing, the author did not have positions in any of the stocks mentioned.