These are scary times for precious metal investors. Resource equities are in the tank and, adding insult to injury, the gold price took a precipitous fall just days before summer, notoriously one of the slowest seasons for precious metals. Heiko Ihle, an analyst with Euro Pacific Capital in Connecticut, tells The Gold Report that something has to give. And soon. Ihle sets out a likely scenario and highlights some miners that are able to produce profitably at current metals prices.
The Gold Report: Heiko, in late June gold had its biggest weekly drop in two years. What's your take on that?
Heiko Ihle: It was set off by far-reaching talk of a slowdown in quantitative easing. However, an awful lot of U.S. dollars are still floating around and the price of gold is pegged to the U.S. dollar. In the long run, companies can't sell gold for less than it costs to take it out of the ground. At some point something has to give.
TGR: So, what's going to give?
HI: Either the cost of mining or the price of gold. Quite frankly, the cost of mining has been reasonably sticky thus far.
TGR: Can miners profitably mine gold at $1,200/ounce ($1,200/oz) and silver sub-$20/oz?
HI: This is the first time in quite a while they've dipped this low, but there are miners that are able to produce profitably at these prices. One is Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE). The company's mine-site cash costs were about $5/oz last year, and we forecast less than $6/oz this year. Even at $19/oz silver, Fortuna will be quite profitable.
TGR: Fortuna is planning in the third quarter to begin a 1,500 ton per day (1,500 tpd) mill expansion at its San Jose mine in Mexico.
HI: At current prices, Fortuna is more concerned about cutting costs than trying to increase production. That said, San Jose is a very profitable mine. It is a great location, fully permitted and operational. The site has a large amount of ore that can be mined over the next decade or two. I would continue to encourage the company to expand the mine.
TGR: What's your price target on Fortuna?
HI: It's $4. Given where the stock is trading, it's actually pretty aggressive.
TGR: What are some of the companies under coverage doing to curb costs in this environment?
HI: There have been some cutbacks in every department. There have been layoffs. I've talked to a number of CEOs who are going to be doing more layoffs. Marketing budgets have been cut. A number of road shows have been flat-out canceled. There are cutbacks on exploration and general improvement budgets. Would Fortuna be expanding its mill if it started the whole process today? Probably not.
TGR: How does this trough compare to previous ones?
HI: There is general disinterest in nonproducing assets. Clients ask me almost every day: Why would I deal with a permitting process if I can get a producing asset for cheap? There's also less interest in small-cap names because investors can buy Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) at a discount. Overall, it's been quite hard to get investors excited about some of the names that we follow just because of a lack of interest in the space all together.
TGR: Many of the companies you cover have operations in Latin America, particularly Mexico. Mexico was the world's largest silver producing country in 2012, with about 162 million ounces (162 Moz), up 6% from 2011. Silver production was up 4% globally in 2012 to 787 Moz versus 757 Moz in 2011. Tell us about your favorite precious metal stories.
HI: Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE), run by Brad Cooke, has a reasonably low cost of production of about $8/oz this year. We forecast about $7/oz next year as the El Cubo plant should be fully on-line.
Endeavour Silver has a great business model. It buys underappreciated mines, puts some money into renovations and puts them into production at much lower cash costs with more efficient operations. The company tends to get a lot closer to reserve grade than the prior owners.
Today, for the first time since I've been looking at this company, Endeavour traded under $3/share. It's a very good value play.