Senior Mining Companies Stocks Still Offer Good Value - Adrian Day


Senior Mining Companies Stocks Still Offer Good Value - Adrian Day

08 March 2011, 08:29 a.m.
By Debbie Carlson  
he commodities rally has lifted the price of resource company shares, but good values can still be found, even in the mining industry, said one investment adviser.

Shares for a senior mining company like Newmont Mining have risen about 90% from their 2008 low when financial crisis hit -but remain about 15.5% off their 2010 high - while stocks for junior miners have exploded as some precious and base metals prices hit nominal record price highs.

Adrian Day, president of Adrian Day Asset Management, said since he believes metals prices will retain their strength, well-run senior mining companies could start to rise further now that they have a handle on all-in costs.

“Some of the senior mining shares are still a good value relative to their historic valuations. The senior gold stocks have lagged the price of gold; they haven’t given investors the leverage they thought they were going to get. But there’s good reason for that: primarily is that the costs have been going up,” Day said.

He said some investors have a hard time understanding that cash costs differ from all-in costs. Cash costs usually reflect the margin cost to produce an ounce of gold, whereas all in costs take into account all other factors like capital expenditures. Investors also need to take into consideration with a company like a miner, what is the cost to replace the ounces they’ve just mined.

“It was only in the second half of 2008 that the North American mining industry started to make a profit despite the huge run in gold. Now we’re seeing those margins beginning to expand. So I think if you look at the seniors – this might be the time of outperformance,” Day said.

Day spoke to Kitco News on the sidelines of the Prospectors & Developers Association of Canada’s conference in Toronto.

Even the junior miners can still offer value – if an investor is willing to understand the huge risk in that sector. When evaluating companies he looks at companies with good business plans, financial strength and good people.

“If you’re looking at ‘Moose Pasture Consolidated’ that’s raising money and putting all of that money in the ground trying to discover something yes, that is extremely high risk. If you look at a company like Virginia Mines they spread the risk. They have six different projects this year--three are joint ventures. The money earned from the joint ventures pretty much pays for their operation. That business model is not high risk at all,” he said.

Being a contrarian investor, the record attendance at a show like PDAC would normally give him pause, but not this time. 

“Normally that will make you a little hesitant, but I think the fundamentals are so strong for the metals that I don’t see it at as a big concern. There are a lot of deals that are getting done here. Everyone I spoke to is talking about the deals they’re doing or having been approached –there’s a lot of activity and again in a way it’s a good thing because if a senior company is getting into a junior’s project, it’s some validation to the project or some validation to the potential of a project,” he said.

The amount of non-traditional money that is flooding into the mining sector has been a big topic of conversation at PDAC, but Day said it’s not necessarily all bad.

“First we need to recognize that the generalists, whether its hedge fund, money managers, or investors generally have been extremely underweight the entire commodity complex for decades. And so it’s perfectly valid that a generalist investor has exposure to commodities. A lot of money coming in - a lot is catch up because they’re underinvested.

The concern is when people do not understand the sector,” he said, adding that when the generalist investor becomes the dominant force it can be a cause for concern.

He said it’s important that new investors in mining understand this is a volatile sector and that big swings both short and long term are not uncommon. “A lot of generalists get spooked by a 20% decline, which to me is a buying opportunity,” he said, adding he has a bullish long-term view on commodities.

So what would give him pause change is afoot in the industry? Three factors: a significant slowdown in China’s economy, interest rates outpacing inflation and mining firms raising excessive cash.

Regarding China, he said he would be worried by a significant, sudden slowdown, not just slowing down to 5% or 8% from Beijing’s current growth target of 8% this year, but to something like 1%.

“If you had a socially significant problem and unrest in China, like food riots, or unemployment in the cities, that sort of thing, that could cause the Chinese economy to dramatically slow to 1-2% or to negative growth. That would be a cause of concern,” he said.

On interest rates, he said to watch how they match inflation. As long as rates keep up with inflation and don’t try to outpace it, this won’t be an issue for gold. He said it’s very unlikely that interest rates on the short-end of the yield curve will rise anytime soon.

The third warning sign would be if companies start to raise an excessive amount of money. There is some fund-raising going on now, but he said from the private placements he’s been involved with, cash is being raised for legitimate accretive business purposes. “If you start to see some of these crazy things where people start to raise far more money than they need and you don’t see an accretive use of the cash, that would worry me. We’ve seen that in past with the juniors because all those shares have to be absorbed. Its’ all supply and demand – it just increases the supply of stocks,” Day said.

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