By Russ Winter of Winger Actionables

An article from Adam Hamilton on the whole fallacy surrounding the precious metals miners is one of the more intelligent reports I have read. It’s worth a close read. In sum, he takes to  task  silly season rationales and the negative psychology toward a group that has already received a severe haircut.

First, he takes issue with the profitability of miners at $1,300 POG. I’ve shown that gross profits versus enterprise value typically runs at 4x now, and sometimes even lower. He puts this in PE terms. And that’s at what may well prove to be a low price in gold and silver. You most certainly don’t see that elsewhere in the inflated markets, where coffee purveyors sell at 38x earnings. Fundamentally, and despite all the negative and bearish parroting du jour, mining has been and still is a very profitable business. The industry’s gross margins have hovered in the 50% to 60% range continuously since 2006.

Hamilton points out that there is zero option value in the shares to account for the potential of higher selling prices. The disappearance of the option value in these shares is highly unusual and, in fact, unprecedented. I have been calling it a free open-ended option. Instead, companies have taken massive accounting write offs to reflect the current anomaly in price. Hamilton suggest this write off is too extreme, and that these firms will have to reclaim millions of ounces once the price anomaly goes away.

He then points out the logic behind rising cash costs. It was by design in order to capture higher POG and produce more. Now the emphasis shifts to higher grades.

Mining costs have indeed been rising, but one thing the bears forever fail to mention is much of this is by design. The higher the gold price climbs, the more gold miners can focus on lower-grade ore to increase their production. Gold miners chose to pursue lower-grade projects, which drove much of their rising mining costs. Odds are cash costs will actually come in lower, since gold miners can modify mining plans in many cases to target higher-grade ore to compensate for a gold-price downturn.”

Next, Hamilton goes after the all-in-cost fallacy, arguing (as I have) that these are sunken costs made by those that discovered the ounces and built the mines [see "Evaluating All-In Costs for Miners"].  The prices of the shares today are at severe discounts compared to prior costs. I’ve cited examples in my work in which mines that produce well sell for less then capex, with deposits thrown in for free. Furthermore, miners have prudently slowed non-critical expenses, like exploration and mine construction. They can easily ramp these activities back up as gold recovers — and it will, with miners emerging from survival mode leaner and stronger.

We’re past due for another fallacy smack down, so to Hamilton I tip my hat. It is gospel as far as I am concerned. One area where I depart from Hamilton, however, is on the subject of depreciating reserves and ounces. Ounces in safer jurisdictions are getting harder to find. The good news for the miners is that the advanced-stage companies have ongoing production and reserves. I’ve chosen companies that can be picked up for a song. The question is: Will miners act now to exploit the opportunity cheaply, or pay up later when POG and POS trend much higher? My view is it is likely that somebody is going to ring a bell, and then there will be a stampede for the better undeveloped properties.