Over the past year, gold and silver shares have fallen dramatically, as is evidenced by the performance of the following ETFs.
- The Market Vectors Gold Miner ETF (NYSEARCA:GDX) is down 30 percent
- The Market Vectors Junior Gold Miner ETF (NYSEARCA:GDXJ) is down 34 percent
- The Global X Silver Miners ETF (NYSEARCA:SIL) is down 23 percent
However, there are some mining companies that have bucked this trend. Some of these are special situation stocks. For instance, Centamin PLC (OTCMKTS:CELTF) is a mining company in Egypt that first saw its stock drop in 2011 when that country was experiencing internal political struggles. The stock fell again towards the end of 2012 as the Egyptian government threatened to rescind the company’s right to mine. As this threat abated, investor confidence grew and the stock rose — over the past year the shares are up 16 percent. However, there were a lot of unpredictable events impacting the shares of Centamin PLC, and that stock’s strong performance over the past year simply erased weakness we saw in prior years.
There are, however, a couple stocks that we can look at that tell us a great deal about how to make money in mining companies. The two companies I have in mind are Tahoe Resources (NYSE:TAHO) and Klondex Mines (OTCMKTS:KLNDF). Tahoe Resources was up 55 percent in the last year, and Klondex Mines was up 57 percent. Both companies have two things in common that I believe, together, combined to engender investor enthusiasm.
First, both companies were near-term producers a year ago, and now they are producers. Tahoe Resources recently began producing at its large Guatemalan Escobar silver mine. The shares performed incredibly well as production became a reality after starting as a mine plan consisting of charts, data points, and calculations. While Klondex Mines hasn’t yet achieved commercial production it began bulk-sampling at its Fire Creek project in Nevada last year, meaning that it was taking large amounts of ore out of the ground in order to analyze them in preparation for future production. Bulk sampling generates enough ore so that the company effectively began producing. More recently the company started operating its newly acquired Midas mill, at which it will process ore from the Midas mine as well as from the Fire Creek mine.
Second, while neither company has released production data both are expected to be low-cost producers. Tahoe Resources’ Escobal mine is going to be one of the lowest cost producing silver mines in the world given the project’s high grades and its substantial byproducts. Klondex Mines is also going to be one of the lowest cost producers given that it has gold grades that are far higher than most known underground gold deposits.
Neither of these two characteristics led to this highly improbable outperformance last year. Rubicon Minerals (NYSEMKT:RBY), which is expected to begin producing at its Phoenix gold project this year, did not perform well over the past year with the shares down 38 percent. But Rubicon Minerals is not going to be an unusually low cost producer. Similarly, Eldorado Gold (NYSE:EGO), which is a very low cost gold producer with cash-costs under $500/ounce last year, has lost a third of its value in the past year.
Ultimately, I think investors are drawn to companies that have made promises of a large cash flow stream that are on the verge of realizing them. It is evidence of managerial competence. It also means that the company in question can withstand low metal prices. Finally, even though investors know that cash flow is coming when it is a couple years away, they seem to not appreciate it so much until they can consider it in this year’s or next year’s estimates — new cash flow makes these investments appealing to a new class of investors.
Tahoe Resources and Klondex Mines have already seen their run-ups as they are now low cost producers. However, I think the strong performance we saw in these companies’ shares in the past year can help us pick other mining stocks for next year that can perform well. Based on this blue-print that we have isolated here it seems reasonable to assume that a company that is going to be a low-cost producer starting in 2015 may display a similar performance in the following year. But given the horrendous performance of the gold price in 2013 and over the past year, the 50+ percent returns that we saw from Tahoe Resources and Klondex Mines might be miniscule compared to what we could see from a similar company in a flat or rising gold market environment. Therefore, I think investors should try to isolate gold and silver mining companies that are going to be producing in 2015 at very low costs, and buy them. In a year’s time, they will likely be very happy that they did.