This morning I read yet another column from a gold analyst who claims that the price-to-earnings ratios of several mining companies are now so low that the miners must be great buys.
Well, excuse me, but mining companies should almost never be bought, or sold for that matter, based on price-to-earnings ratios!
The decision as to whether or not to buy a miner should be based on the following criteria, and its price-to-earnings ratio should almost never factor into your decision. The factors you should look at are:
The amount of gold and/or silver reserves the company has.
The Enterprise Value (EV) per ounce of minable metal and per resources. That’s calculated as the market capitalization of the firm plus debt, minority interest and preferred shares, minus total cash and cash equivalents, divided by minable metal and then by resources to get two different figures.
The Total Cost of Ownership (TCO) of just the mineable reserves. That’s the EV of the firm including mineable gold and/or silver, developments and cash costs.
The “all-in sustaining costs” to produce an ounce of gold or silver. That’s bascially everything it costs to produce an ounce of gold or silver and to maintain the mine’s life. You can see the calculation in this table.
Additional factors you should consider include:
Determining whether or not the company can cheaply finance the huge capital expenditures that are involved in the mining process.
The expertise of the company’s management.
Importantly, whether or not the company hedges or plans to hedge.
How much debt the company has and at what interest rate.
Where its properties are located.
And more, including the very important skill of timing your purchase of the company’s shares when it’s truly time to buy!
Obviously, there’s a lot more to investing in mining shares than simply looking at price-to-earnings ratios. This is why I repeatedly feel I have to warn you about all the misinformation that’s out there.
The simple truth is that …
A. Miners have not yet bottomed.
That’s a no-brainer really, since neither the price of gold, silver or copper, nor any other metal for that matter, has bottomed.
Sure, there will be some short-term rallies in miners, some worth playing for those who want to speculate. And sure, the losses miners have taken since their peak are incredible, with the top 10 miners in the world having lost nearly 90 percent of their value and a whopping $540 billion of shareholder equity.
But overall, the mining sector has not yet bottomed and I see as much as another 50 percent lower from current prices.
B. When they do bottom, you’re going to have to be extremely careful which mining shares you buy.
For instance, on an initial screening I did this weekend, of 150 publicly-traded mining companies, I have already crossed off 129. There are now only about 21 miners on my radar screen that are worth monitoring.
Of those 21, probably only four or five will make it on to my long-term buy list.
So of those 150 I’m looking at, less than 5 percent will make the cut-off grade for my money, and obviously for yours.
This initial screening will change, since the metals’ bear market is not yet over. I expect it to change substantially, but the bottom line is this: Now is NOT the time to buy mining companies.
Now for a quick update on the metals themselves: Expect a short-term bounce to continue, but then the downtrend will resume into a highly probable and very important low in mid-November.
And the stock market: Its bounce also will soon end, leading to new lows heading into October.
Best wishes, as always …