Commodities Week in a Minute: Breaking down the Au/Ag opportunity. Diamond prices higher, plus more...



Diamonds and precious stones

Given the multiple sales either just closing or currently underway, the news that average prices at De Beers’ last sale rose between 2%-3% as supply was limited to align with lower polished diamond sales, is both positive and negative.

Positive for producers near term – which will likely be reflected in average prices (all things being equal) so consider Gem Diamonds, Lucapa and Firestone for possible trading ideas as they are more susceptible to movements on average prices right now (Petra is being held back by the legislative changes in SA).

But before we all get carried away, polished demand is not great right now. This could change as optimism is growing for an extension in the recovery of Chinese retail growth rates given the trends announced from the likes of Chow Tai Fook and Luk Fook. The Hong Kong show will help in this regard.

Precious metals

Following on from this morning’s BoB, I have been increasingly looking at the Au/Ag ratio and whether or not it can offer an investment opportunity. I am going to use a time frame of the last 20 years, whilst I could use a longer time frame, industrial demand trends for silver have changed considerably vs. those back in the 70’s and 80’s (although the theory still holds).






Cross rate


Graphically the distribution looks like:


From this we can infer from historical analysis:

• Ratios of less than 20 and between 20 and 30 are uber rare. Whilst they did occur briefly in 1980, the silver markets were being manipulated by the Hunt Brothers.
• Monthly ratios between 30 and 40 have only been seen 3 times (1.24%), whilst monthly averages of between 40 and 50 occurred 10.4% of the time. These ranges should be seen as a realistic limitation to any trading opportunity.
• Interestingly, the monthly average between 50-60 (35%) was actually higher than that of 60-70 (31%) but clearly implying a mean average range for the period studied.
• A ratio between 70 and 80 starts to clearly highlight an opportunity at (21%) but broken down, 65% of the time the ratio was below 75 clearly indicating an upper range, or entry opportunity.
• Finally. For those concerned of the risk of going too early, monthly averages of >80 occurred twice, or <1% of the period under consideration.

Simply put, unless you are concerned about a major collapse in silver demand, a ratio between 75 and 80 can be considered a good buying opportunity for a longer term trading opportunity and even a reversion back to the longer term average of 65 and a flat gold price, would imply a return of 14%, back towards 60 and you are looking at a 25% return. That alone is worth some consideration.

Company announcements/news/meetings:

Daily company commentary is now covered in our Boom Ore Bust publication, but I have pulled out some of the more investible ideas below.

Firestone Diamonds – Guidance cuts reversed, Standby facility change reduces near term cash concerns (LON:FDI, Mkt cap: $167m) – Positive

After guiding forecasts lower in April (to 300kcts from c400kcts) management are today increasing production guidance 20% to 360kcts as a result of improving throughput rates, plant availability as well as the anticipated increase in grades via migration to higher value areas of the Liqhobong ore body pipe.  Positively, the Company has also commenced quarterly repayments under the terms of its US$82.4 million ABSA debt facility, having achieved first production, and making its first capital repayment of US$1.4 million in March 2017.

Additionally, the US$15.0 million standby facility provided by RCF that expires on 30 June 2017 has been extended by a further year to June 2018, subject to an immediate draw of US$5.0 million. The US$0.3million cost of the facility is to be satisfied by the issuance of 556,680 shares. All other aspects of the facility remain the same.

Firestone’s share price has been drifting for some time now as concerns over a potential fund raise has swirled in the darker areas of the market as the fallout of the previous guidance cut got rumours started. Today’s announcement, we believe, can put this to bed for now and with the RSI down to 15, buyers have been absent for a while. We think today’s announcement will go some way to reversing this trend. Also worth considering the company will be concluding another sale this week, we would be picking up any loose stock if the opportunity should arise…

Polymetal – EBRD provides $140m loan for Kyzyl (LON:POLY, Mkt cap: $4.9bn) – Positive

Polymetal has announced that it has signed a US$140 million loan agreement with the European Bank of Reconstruction and Development to fund the remaining capital expenditures for the Kyzyl project, which is scheduled to launch in the third quarter of 2018. The facility has an effective tenor of 5 years with a final maturity date in December 2022.

It is worth noting that Kyzyl is set to be the flagship operation once production commences. Kyzyl is a high-grade, world-class deposit with total reserves of 7.3 Moz at 7.7 g/t of gold and an initial mine life of 22 years. Once at full capacity in 2019, the asset is expected to contribute more than 300Koz of gold equivalent ounces per annum.

Today’s announcement has been a long time coming with the EBRD facility long anticipated. Interestingly, given many prejudices Russian mining companies face, the requirement to develop an Environmental and Social Action Plan together with the EBRD, which includes a series of actions that the Company has committed to in order to avoid, reduce, control, or mitigate potential environmental, health and safety, and social impacts during the construction and operation of Kyzyl, can be seen as another step to wider investor acceptance.

Gemfields – Pallinghurst gets the mine, shareholders get the shaft (LON:GEM, Mkt cap: $285m) – Negative

Initially we were very pleased to see that Fosun gold had confirmed an all-cash offer totalling 45p yesterday which won the seal of approval from the independent management team. However, after the market closed Pallinghurst confirmed that with only 14.16% of votes in favour, together with the 47.09% already held, the takeover panel has agreed to lower the acceptance condition from 75% to 60% meaning with 61.25% of votes now in favour, the offer has gone unconditional.
The last remaining hurdle is the passing of the Resolution to approve the offer at the Pallinghurst General Meeting, which will be held at 11:00 a.m. (London time) on 26 June 2017. This resolution requires approval by 50% of votes cast at the Pallinghurst General Meeting. Interestingly, Pallinghurst noted that it has irrevocable undertakings from Pallinghurst Shareholders in respect of a total of 382,450,612 Pallinghurst Shares (representing approximately 50.3% of the Pallinghurst Shares in issue) to procure that their shares are voted in favour of the necessary resolutions on which they are entitled to vote proposed at the Pallinghurst General Meeting.
Despite a far higher offer on the table for shareholders, Pallinghurst look as though they could conclude a repeat of their favoured play where they squeeze out minority shareholders who have carried the company through its high risk development phase. The other factor to consider here is the proposed extension of the Pallinghurst management agreement, which happens to be up for renewal this September and the small matter of 157.93million shares for the “management share plan” worth a cool $40m on today’s depressed equity valuation… Add 100% of Gemfields and this little perk could easily be worth closer to $100m. Becomes obvious now, doesn’t it!

Rio Tinto - $2.5bn debt reduction plan completed (LON:RIO, Mkt cap: $71.8bn) – Positive

Rio Tinto has successfully completed its bond tender and redemption exercise announced on 22 May 2017, reducing gross debt by a further $2.5 billion through both a redemption and tender programme. It is worth noting that since the start of 2016, Rio reduced the nominal value of outstanding bonds from approximately $21 billion to approximately $9.5 billion.
Despite the concerns over lower commodity prices permeating through the market as many analysts mark to market their forecasts, the cash generative characteristics at Rio Tinto remain strong. The company is currently trading on a spot FCF yield of ~10%, twice that of the average yield during the worst of the iron ore price declines in 2012-15. To see FCF yields at 5% (in the absence of SP appreciation) one would need to assume the worst commodity prices from in Q1 2016 (Fe: $45, Cu: >20% lower) into perpetuity. We think that is unlikely. Stick with the winners.

That's enough from me today


Stay strong



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