Win consistently with commodity stocks by being contrary. Plus! Using the “E” word with SSRI.

Dec 15

Win consistently with commodity stocks by being contrary. Plus! Using the “E” word with SSRI.

Getting to the bottom line right out of the gates___ earnings of commodity producers look horrendous in the bottoming phase of a cycle.

Said another way, as commodity prices are peaking, the earnings power of commodity producing companies is spectacular! Price-to-earnings (P/E) ratios are typically 10 or less (so they look cheap) near a peak, and often above 100 or non-calculable (so they look expensive) when commodity prices are near the valley.

To win consistently with commodity related stocks, one must do the opposite of what traditional metrics such as P/E would suggest >>> Sell when earnings power is strongest and buy when earnings are weakest. The strategy sounds straightforward, and it is, but it’s so damn difficult to implement (patience is required).

…most people prefer instant gratification and following the herd, so they’re constantly chasing (for better or worse).

How do you know when earnings are strongest or weakest?
Only with the benefit of hindsight can you know with 100% accuracy, but you can get an idea of where in the cycle you are based off what the industry and financial world is doing and saying.

For example… let’s look at the oil industry… what moves are they making now?

They’re cutting all non-essential expenditures, firing employees en masse, and struggling to pay bills. Expectations have been mitigated to the point where merely “staying in business” is the goal for many. With oil below $40, just about every balance sheet in the industry looks ugly, and based off conventional wisdom in December 2015, its tough to imagine a scenario that propels oil back above $80.

How’s that for investor confidence and psychology?

Have you heard anyone predicting oil will do anything but go down lately? –i haven’t.

Yeah! Not too many people out there getting aggressive on the oil space right now. P/E’s are very high or non-existent, so this is the time for investigating (building a buy list) while things are at or near the worst. It might take a few years for the industry to recover and shake out the poor performers, but oil will not stay below $40 forever.

Now think back to years 2010 – 2014, oil was consistently above $90 per barrel, and the general consensus was higher prices ahead. Most companies financials were looking pretty solid, P/E’s were relatively low. In fact, things “appeared” so good that Grannies and PaPas were tripping over themselves to lend money (heck 7% sounds good) and buy oil stocks (at the recommendation of their trusted advisor of course) precisely as the environment looked brightest, storm clouds were gathering.

Boom, bust, and repeat
Knowing commodities go through boom and bust cycles, as they always have, being aggressive when things are booming is not a recipe for consistent success, is it?

Psychologically speaking, selling when everything is awesome (BOOMING) and buying when everything is shitty (BUSTING) is almost impossible. But, I’d guess 5% of the investing population does it over and over again. With research and mental toughness they are consistently winners, just not overnight.

Instant gratification is a dangerous want to have when playing in financial markets.

All righty then! Ready to make some money?

The “E” Word
Rarely, if ever, for fear of appearing naive or having my neck chopped off, will i use the “E” word, but in my view Silver Standard Resources (NASDAQ: SSRI) is an easy 50% gain from here.

When investing during a bust-like environment, we’d prefer to buy a premium product that’s priced cheaply. Knowing we can typically throw earnings metrics and P/E ratios out the window (caveat here, the best of breed companies may maintain positive earnings throughout the down cycle), i prefer to focus on a “sum of parts” type of valuation/analysis.

At $5.09 Silver Standard Resources (SSRI) is selling for $410M

My back of the envelope calculation suggests SSRI should be worth $655M

Why do 5% of contrarian/value investors almost always make great returns when buying assets during a bust? –Because they’re paying a large discount to underlying value and any upside potential for commodity prices (therefore higher earnings) is free.

Below, in all its simplistic glory is how i arrive at a $655M valuation or $8.11 per share for Silver Standard Resources.

Sum of the parts = $655M
$200M cash
= based on the November 2015 corporate presentation

b) approx $85M worth of Pretium Resources (NYSE: PVG)
= based on Pretium’s corporate presentation SSRI owns 11.8% equity

c) $275M Marigold mine Nevada; 195-205k ounces of gold production
= based off the price paid to acquire the mine and all assets from Goldcorp and Barrick. If Silver Standard believed this mine, with an estimated 9-years of life ahead, and roughly $150M worth of new equipment was worth $275M toward the bottom of a cycle, why shouldn’t i believe its worth at least $275M. After a year of ownership production has increased by 50% and cash costs have decreased by more than 10%. Perhaps one could argue Marigold is worth more as a result.

d) $95M Pirquitas mine Argentina; 9.5-10.5 million ounces of silver production
= based off historical acquisitions, in my view Pirquitas should be worth at least $10 per-ounce of current production, when considering the significant silver and zinc reserves/resources that remain.

Of course, the back of the envelope calculation above applies ZERO value to 9 development and exploration stage projects in Silver Standard’s portfolio. One [Pitarrilla] is among the largest undeveloped silver resources in the world, with an estimated 695 million ounces in-ground. Arguably, if silver prices ever appreciated to more than $25, Pitarrilla could fetch, i dunno, maybe 50cents per-ounce in situ.

Final Thoughts:
Valuing SSRI based off a suite of alphabet soup financial metrics could paint an ugly picture– sell, or for goodness sake don’t buy! But based off a simple back of the envelope calculation of tangible assets SSRI looks like a no brainah’ to me. Also, when considering the bearish/pessimistic sentiment, and SSRI trading like its 2003, it certainly doesn’t feel like a sexy idea.

Technical traders out there? SSRI is in somewhat of a stealth uptrend-channel, hear me out below…

a) October 2014 is $4.37 low

b) March 2015 is higher low @ $4.53

c) November 2015 is another higher low @ $4.80 (*higher highs along the way mind you)

**Now i’m no Chartered Market Technician (CMT), certified technical analyst or anything, but after recent sharp pullback from $7.52 >>> $5 and change seems like a low-risk entry point to grab some SSRI.


Daniel T. Cook

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*Author has a long position in Silver Standard Resources Inc.


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