Value buys in gold and silver

These haven holdings offer an excellent opportunity for defensive investors.

By TheStockAdvisors Oct 19, 2012 10:07AM

Anthony Bradshaw PhotographerBy J. Royden Ward, Cabot Benjamin Graham Value Letter

In an effort to increase the defensive holdings in our value portfolio, we've added one gold mining and one silver position to the portfolio: Barrick Gold (ABX) and Silver Wheaton (SLW).

Barrick Gold, based in Toronto, Ontario, operates 26 mines in North and South America, Australia and Africa with three additional mines under construction. Silver Wheaton, based in Vancouver, British Columbia, purchases silver from mines in Greece, Mexico, Peru and Sweden. The company does not own or operate any silver mines, but purchases silver produced as a by-product of gold mining companies.

Barrick Gold undervalued
Barrick is conducting many exploration and development mines. The projects are expected to provide substantial production in future years.

Barrick derives 34% of production from North America, 33% from South America, 22% from Australia and 8% from Africa. It also mines significant amounts of copper.

It purchased Equinox Minerals in 2011, which is adding valuable copper assets to its holdings. Equinox is already increasing Barrick's earnings per share.

Barrick expects to begin gold production at two new major mines within the next 12 months. The mines' construction costs are rising, but the cost of mining gold at the new mines is expected to be significantly lower than its average cost of $540 per ounce.

The company reported disappointing results for the quarter ended June 30. Sales declined 4% and earnings per share dropped 35%. Lower copper and gold production was exacerbated by lower metals prices.

I expect the price of gold to rise noticeably during the second half of 2012. New mines will boost production. I forecast revenue growth of 10% and EPS growth of 9% during the next 12-month period ending June 30.

Investors often invest in gold when geopolitical situations become strained. Unfortunately, the unrest in the Middle East and North Africa will continue and European debt problems will persist.

Gold offers a safe haven to hedge against future uncertainty, and the recent slide in Barrick's stock price offers an excellent opportunity for investors.

At 10.8 times current earnings per share and a dividend yield of 1.9%, ABX shares are clearly undervalued. ABX is low risk.

Silver Wheaton may win more contracts

Silver Wheaton pays less than $4.00 per ounce of silver from gold mining companies such as Barrick Gold and Goldcorp (GG).

The company owns purchase agreements on proved and prolific silver reserves, such as Goldcorp's Penasquito mine in Mexico and Pascua-Lana mine in Peru. Silver Wheaton contracts are very profitable and will produce rapid revenue and earnings growth well into the future.

Slower silver shipments caused sales to increase only 3% during the second quarter, while earnings per share declined 5%, worse than expected. Silver Wheaton's silver production increased 10%, but silver prices dropped 24% from a year ago.

The company recently inked a new contract with Hudbay which will add immediate cash flow with future costs fixed at current levels.

Silver Wheaton is in an enviable position to win new contracts at favorable rates when silver prices fall. The company has over $1.1 billion in cash with almost no debt.

Silver Wheaton raised its quarterly dividend to $0.10, which now yields 1.0%. Sales and earnings will likely increase 25% and 29% respectively in 2012.

The lower price of silver and the decline in SLW's stock price offers an excellent buying opportunity. SLW shares are medium risk.

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