Over the past several weeks, we have seen the shares of most precious metals mining companies soar along with gold and silver prices. Thus, so far this year, we have seen the following gains.
- Gold is up 9.5 percent.
- Silver is up 10 percent.
- The Market Vectors Gold Miners ETF (NYSEARCA:GDX) is up nearly 25 percent.
- The Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ) is up a whopping 38 percent.
- The Global X Silver Miners ETF (NYSEARCA:SIL) is up 30 percent.
It seems that a rising tide is lifting all boats. But the real winners in the precious metals bull market will be those investors who are able to differentiate between the best and the worst companies in the sector.
Therefore, in this article, I am pointing out three precious metals mining companies that I think investors should avoid. If gold and silver continue to rise, as I believe they will longer term, their shares will likely follow suit. However, at some point, the market will differentiate between precious metals miners and the companies I point out here will be left behind.
The first is Tanzanian Royalty Exploration (NYSEMKT:TRX). This is one of the better performing stocks year to date, having risen 50 percent already. It is one of the better known smaller gold mining companies because its CEO is precious metals guru Jim Sinclair. However, investors who take a closer look at this company will quickly realize that there isn’t a lot of value here.
The company’s flagship project is its JV Buckreef property in Tanzania. The company owns 55 percent of the project while the Tanzanian government owns the remaining 45 percent. While the property has a nice sized resource of 3 million ounces of gold it is only going to produce 113,000 annually, or 62,000 ounces attributable to Tanzanian Royalty Exploration. Furthermore, the project has an initial capex of $125 million. But while Tanzanian Royalty Exploration only owns 55 percent of the property, it has to foot the bill for all $125 million. It is going to have trouble doing this with just $8 million in cash, equivalents, and short term investments.
Furthermore, once in production the mine will only generate around $7 million or so annually in attributable cash-flow. This is simply not enough to justify a $125 million expenditure or a $247 million market capitalization. While the company has other projects they are small and it has yet to release mine plans for them that show that they will be profitable to operate. Ultimately, unless the company finds a lot more gold or unless the price of gold rises substantially from here, the shares should fall.
The second company I think investors should avoid is Excellon Resources (MKTS:EXLLF.PK). Investors have bid this silver producer up 40 percent this year. At first glance, there is a lot to like about this company. Its flagship Platosa mine is the highest grade silver mine in Mexico. Therefore, it has relatively low production costs and it can generate a profit at $21/ounce silver.
However, the mine is simply too small to justify the current valuation. It will produce 1.4 million ounces of silver per year, but it has less than 20 million ounces of silver. Furthermore, many of these ounces are in the “inferred” category. This means that the company believes that they can probably be extracted profitably but this claim is speculative. This means that the company is running out of silver.
Right now, the company is claiming that the mine can operate for another 8-10 years. It produces silver at $14/ounce, which means it can make about $7/ounce in pre-tax profit at $21/ounce silver. Given Mexico’s high tax rate of 30 percent plus a 7.5 percent mining royalty that comes right off the top the company has to pay an effective 35 percent tax on its mining profits. The means that it is really only making $4.50/ounce, or $6.4 million per year. At 10 years of production, the company will generate just $64 million in cash-flow, which is less than the company’s $84 million valuation. But keep in mind that production might only be 8 years. Also keep in mind that future cash-flow is worth less than present-day cash-flow.
If this cash-flow loses just 5 percent of its value per year, the total cash-flow is worth just $52 million. If we use an 8 percent discount rate instead of 5 percent, which is the rate I like to use to pick mining companies, then the cash-flow is worth just $47 million. Ultimately this company has to find more silver in order to become appealing, and recently it hasn’t been finding any. Therefore this is a stock I want to avoid.