Dave from Denver...

Monday, June 18, 2012

Just How Cheap Are The Junior Mining Stocks?

Short answer: historically cheap. For those who want an explanatory answer, continue reading.

Anyone who participates in or follows the mining stock sector has read the numerous commentaries recently describing the extreme relative undervaluation of the mining stocks, especially the juniors. In fact, I saw an article this past weekend which demonstrated that the last time the mining stocks, in general, were as undervalued as they are right now was in 1924.

Regardless of which relative value thesis to which you are want to subscribe, there's no question that the mining stocks as a sector have become extreme value plays. "Value" as opposed to high growth rate speculative plays (like Facebook, for instance). And while it's true that vs. "benchmark" metrics, the miners are cheap, for my investing capital nothing reveals "market truth" like a point of trade. "Point of trade" being that economic intersection at which a buyer is willing for fork over money and a seller is willing to fork over the goods.

Monday provided us the with truth benchmark of an actual trade. Yamana (AUY) bought Extorre Gold (XG-TO, TSE-listed) for $414 million, mostly cash/some stock. If you net out the cash on XG's balance sheet of $27 million, this price represents $161/oz of XG's total 43-101 resource of 2.4 million gold-equivalent ounces (XG's defined gold plus silver converted to "gold equivalent"). The price was a 68% premium to XG's closing price on Friday.

The high premium to Friday's close is one way to view the current relative undervaluation of these mining stocks by the stock market. Furthermore, the $161/oz price is substantially higher than the "generic" $100/oz price of some recent acquisitions.

To be sure, the high quality attributes of XG's deposit - like the expected high metallic recovery from the ore and anticipated low cash costs of production - would induce an acquirer to "pay up" a bit for XG. But these highly attractive features are offset by the fact that XG's trophy property is in Argentina, which presumably poses considerable political risk now that Argentina's Government has demonstrated a willingness to nationalize foreign-owned oil companies.

The Wall Street genius analysts, in their desire to come up with reasons to try and convince institutional investors to avoid the sector because Wall Street has very little ability to make money off the mining stock sector by shuffling around paper financing deals and skimming big fees, would tell you that the political risk of most mining stocks is the best reason to avoid them. In fact, not one single U.S.-based brokerage firm covers Extorre: LINK I guess Wall Street's finest have plenty of ideas up their ass that will generate a 68% gain...

Throwing Wall Street aside, besides the fact that this Truth Revealing trade shows just how cheap the mining stocks are - especially the junior miners - it also tells me that the most sophisticated possible buyer of mining assets - an actual successful industry operator - has determined the political risk in South American countries like Argentina is substantially less than is being discounted by the market. As a result, I expect to see several smaller junior mining stocks experience a strong price move higher.

One company I like that has substantial exposure in Argentina is McEwen Mining - MUX. MUX has had the crap beaten out of it because of the perceived political risk of Argentina. MUX traded up over 6% today. Most of that gain is attributable to the AUY/XG deal. But MUX is still 57% below its 52-week high of $7. I am betting that MUX closes that gap relatively quickly and move a lot higher than $7 as the next big move in this sector unfolds. Oh, by the way, Rob McEwen of McEwen Mining is the same McEwen who guilt Goldcorp into one of the largest and most successful gold mining companies in the world.

About two years ago Goldcorp paid over $1,000/oz. for Andean Resources, which is situated mainly in Argentina. That's a good benchmark for where the market is headed until the real "internet bubble" dynamic kicks into gear in this sector.