Sometimes, the bottom is best place to be when it comes to investing. It may mean that you’re getting a good deal (i.e. buying on the dips) or it could simply mean your risk-to-reward ratio is too attractive to pass up. The latter is much the case with gold mining stocks at the moment.
When we speak about optionality, we essentially refer to the way that risk is leveraged. An investment might be extremely risky, but if the cost is relatively low and the reward is very high, it has good optionality. The presence of high optionality means you can stash an asset away with the option for high potential payoff.
The mining industry is now at extreme lows, but can it offer optionality?
With mining firms that are making cuts in order to survive but are sitting on yet-untapped resource deposits, optionality is indeed high. An article on Mining.com makes this case for several mining companies with fantastic amounts of gold deposits at their projects but insufficient capital to launch the actual extraction of the metals from the ground.
The common thread, at least in the current bear market for commodities, is that these companies have low G&A (general and administrative) expenses. These are the costs of day-to-day operations; mining companies that offer great optionality will generally minimize their G&A costs in order to weather the storm. This means that they’re leaving their mines idle, paying only for the bare minimum of care and maintenance. Yet it also means that they will survive—another (obvious) required condition.
Optionality in Silver Mining
One good example of this dynamic can be seen in Endeavour Silver (NYSE:EXK; TSX:EDR). They are a relatively small miner by most standards (market cap < $125 million) and cannot afford to run all of their operations in such a low price environment. However, the company operates a number of mines in Mexico, the most silver-rich country in the world (and consistently the world’s top producer of the metal).
It’s not that these mines disappear or that their deposits are somehow subject to spoilage. They are merely hunkering down in order to get leaner in the near-term.
To reduce its G&A expenditures, the company plans to scale back and cut its annual production by 25%. This should help Endeavour in the long-run—and as is the case with high-optionality gold miners, shows great growth potential when metals prices recover. The advantage lies in the currently depressed prices for gold and silver: EXK shares currently trade for about $1.25 each, down from a high above $12/share just a few years ago.
Best of Both Worlds?
Sometimes, even a strong performance from a large firm can have optionality underlying its operations. A good example of this so far in 2016 has been Barrick Gold (NYSE, TSX, SWX:ABX). ABX has been the best-performing stock on the Toronto Stock Exchange (TSX), advancing nearly 30% so far this year.
Yet, even as it reclaims the title of the highest-valued gold miner in Canada ($11.5 billion market cap), Barrick is partnered on mining projects that boast 4 of the 25 largest untapped deposits. In this case, even a high-end miner offers optionality to investors.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.