Two Value Gold & Silver Stocks: GOLD and PAAS

Declan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It was only last August that speculation bubbled around gold reaching $2,000/oz, but it didn't take long for investors to cash in their chips and wait for another day as the metal topped out at $1,923 / oz.  Public interest in gold stocks also reached a peak in August, with Google Trends showing a sharp spike in online searches for gold mining stocks.  But once it became apparent gold wasn't going to break $2,000, both public and investor interest waned.  Indeed, public interest has dropped so low that the volume of searches and news related items for gold stocks is now at the June 2011 level, which was when gold prices went on its rally binge.  Is now the time to pick-a-pocket or two?

In my value scan, I seek out stocks which exhibit good EPS growth and return on equity.  Two mining stocks were able to make the grade: Randgold Resources (NASDAQ: GOLD) and Pan American Silver (NASDAQ: PAAS).

Randgold Resources has recently found itself mired in bad news around its Mali operations, a major interest for the company. Adding fuel to the fire was Bernake's testimony, which plunged gold prices as further stimulus was ruled out.  Certainly investors weren't keen to roll the dice on the stock, sending it from $118 in early March to a low of $80 by the start of April, before prices recovered a little.  But is the sell off justified?  This is a company which had a comparative year-on-year quarterly growth of 328% and an annual growth in revenue of 117%, so its certainly a company which has enjoyed dramatic earnings growth. 

 Looking at its troubled Mali operations, reported production in Loulo-Gounkoto mine (its key interest) was 346,000 oz in 2011 and with a forecast production of 500,000 oz for 2012.  It's other Mali mine in Morila is winding down production and is less impactful on earnings.  The company recently announced projected production for its Kibali Project, in which it has a 45% stake. First production is set to start by the end of 2013 with an annual production of 600,000 oz in the first 12 years with an average grade of 4.1 g/t.  This is almost double the production of its current Mali operations with a higher gold concentation.  So while investors focus on its Mali operations, Mali is not Randgold's only iron in the fire.  The selling in the stock is likely to continue until events in Mali stabilize, but using a dollar-cost-average approach this shouldn't be issue; one isn't looking to pick a bottom, but to be buying while the market figures out the fair price for Randgold.

The second stock, Pan American Silver, has been hit by a severe case of buyer phobia.  TheStreet recently highlighted the stocks' 52% decline in share price, but also noted "Investors have so far failed to pay much attention to the earnings improvements the company has managed to achieve over the last quarter".  However, this didn't stop TheStreet from ignoring the positives and keeping a negative outlook on the company.  Of the two stocks, it is certainly the one most out of favor.  It has been dripping losses from its peak of $42.98 in 2011 to a current low in the $19s and doesn't look like it's going to stop anytime soon.  A similar decline from $43.86 in 2008 didn't reach its low until it got to $9.05; which at least offers some guidance for potential buyers.  This price drop has occurred in the background where YTD to last YTD EPS growth was nearly 2,500% and quarter-to-last quarter earnings growth of 1,615%, which was fuelled by Silver's sharp rise in price from a 2008 low of $8.40/oz to a high of $49.82 in 2011, although the most recent quarter came in below estimates.  But the subsequent 36% drop in Silver prices doesn't equate to the much larger drop in Pan American's share price.  Production expectations for the next couple of years are comparable to 2011, so any improvement to underlying profit will be dependent on a gain in silver prices. 

The prospects for higher gold and silver prices remain good.  Gold is a function of debt and a hedge against inflation, and while gold may be precious and rare, debt is anything but.  Europe's ongoing debt crisis combined with low-level interest rates in the U.S. are both key inflation drivers (despite Bernake's recent comments).  The solution to the European debt crisis has effectively been to double down by issuing more debt. But instead of using the money to drive growth and stimulate the economy, Governments bailed financial institutions out of their losses.  In turn, financial institutions sit on replenished cash reserves; not wanting to lend to struggling businesses.  To compound the problem, sovereign bailouts have come with harsh austerity plans; crippling the consumer and lowering demand for produced goods.  Less consumer demand and a lack of finance from banks kills business and costs jobs. 

The cycle continues until either money is placed in the pocket of the consumer through lower taxes, and/or banks start lending to business to generate growth.  As austerity is the flavor of the month in troubled economies, the former is unlikely to happen; and it would appear an assumption was taken on the latter when banks received bailouts without preconditions.  So in the absence of a stimulus, economies can't recover and service the debt. This means more debt will have to be issued to cover 'old' debt; a perfect storm for inflation-based products like Gold and Silver. To add to existing pain, a slowdown in Chinese consumption will add further pressure to struggling business and send funds flowing from stocks into commodities and commodity based issues. 

Given the aforementioned landscape, it could just finally be time once again to pay heed to both gold and silver.


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