The Commodity Investor Q&A
By Matt Badiali
November 19, 2008

Q: The general selloff left some stocks at incredibly low prices. How do I figure out which ones to buy now and which ones are going out of business? – G.I.

A: All it takes is a little homework that's no more complicated than balancing your checkbook. Let me show you with two real-life examples: Barrick Gold (ABX) and Agnico-Eagle Mines (AEM).

These big-cap gold miners both suffered as gold's price fell: Agnico-Eagle dropped 76% from this year's high, and Barrick is down 69%. But before you buy them thinking they're cheap, you need to know three things: how much money they make, how much money they spend, and how much money they have in the bank.

Here's how our gold miners' numbers break down:

I multiplied last quarter's earnings by four to get expected income. Because gold prices have fallen, that should give us the most conservative estimate. And for costs, I only used SG&A (selling, general, and administrative expense) plus interest payments on debt. These are bare survival costs, which tell us if a company can keep its lights on and its creditors at bay.

As you can see, Barrick will make enough income to cover its costs. But Agnico-Eagle will be short: $44 million in, $92 million out means the company will lose $48 million next year.

Agnico has $112 million, so it can handle about two years of $48 million losses before it's out of cash. Because I believe the price of gold is going up, I think that's a reasonable amount of padding for a gold miner.

So Barrick is in good shape. And Agnico-Eagle is in OK shape. But take a look at Jaguar Mining (JAG), a $142 million gold producer. The company will bring in about $8 million next year but will spend about $39 million to keep the doors open. It only has $1.5 million in the bank – enough to pay the bills for about two weeks.

If Jaguar wants to stay in business, it will have to raise money issuing shares. That's a tough task in this market. So depending on the quality of its assets, the company will probably get bought or go bankrupt.

We'll be seeing a lot of that in the next 12 to 18 months. So check the numbers before you go bargain hunting.

Q: I think the trillions of "bailout" dollars are going to cause rampant inflation. That should make silver and gold soar. I'm interested in silver miners to leverage the idea. Which ones do you recommend right now? – J.A.

A: I agree that the U.S. government can't create trillions of dollars out of thin air without making all the existing dollars worth less. That is the definition of inflation. I think the safest place to protect your cash is in precious metals. And if you're looking for a little extra "juice," silver miners are the way to do it...

Since 1979, mining companies did about 2.6 times better than bullion. In addition, silver is unusually cheap compared to gold. The 30-year average is about 61 ounces of silver to one ounce of gold. Today, it's around 78 to one. That means the price of silver would need to rise 26% (to $12) to hit the average.

In addition, the market's offering some great deals in silver miners right now. But again, not all cheap mining stocks are created equal...

Take Apex Silver (SIL), for example. Back in May, the company owned 65% of San Cristobal, the world's fourth-largest silver mine. San Cristobal was slated to produce about 16.9 million ounces of silver and 247,000 tons of zinc per year. Silver was selling for $18 an ounce, and analysts projected Apex would make over $800 million in profits this year.

Meanwhile, shares of Apex Silver were down 50% from their high – it looked like a steal. Big-name investors like George Soros and Brazilian billionaire and celebrity CEO Eike Batista piled in.

Since then, Apex Silver's share price has fallen 93%. But it's definitely not a better bargain. Silver dropped 43%, zinc is down 50%, and the company got caught with its pants down: too much debt and not enough cash to keep going.

This week, Apex announced it would sell its stake in San Cristobal to its partner, Sumitomo, for about 7¢ per ounce of silver reserves, with 1.95 billion pounds of lead and 5.2 billion pounds of zinc thrown in free. This is what happens when a mining company runs out of cash.

Are These Energy Dividends Safe? What to Expect from Two Bull-Market Darlings

A better option for silver bugs is Silver Wheaton (SLW), which owns royalties on other companies' mines. Like Apex, SLW got crushed with silver's fall. The stock is down from a high around $20 to below $3. But unlike Apex, I think SLW is a bargain...

At $3 per share, you can buy SLW below book value. The company will make about $80 million this year, but only spend about $17 million. And it holds $125 million in cash. It looks like a fantastic way to own silver production.

Good investing,

Matt

Hedge Funds Buckle, Take Down NY Real Estate
At least 300,000 square feet of platinum-plated space is already up for grabs. A record 70% of hedge funds reported losses through September, and the average fund lost 15.4% of its assets through October – the biggest drop ever, according to Hedge Fund Research Inc.

Through June, 350 hedge funds liquidated. If that pace continues, the number of liquidations could be 25% higher in 2008 than in 2007. Meanwhile, fewer funds are being founded. Read on...

Billionaire Buys Toxic Debt
John Paulson, the hedge fund manager who was called before Congress last week to discuss the big profits he made by foreseeing the collapse of the subprime mortgage market, has started to buy securities backed by residential mortgages.

Mr Paulson's move marks the latest example of a famously bearish investor shifting gears to profit from depressed prices in the global credit markets. FT($) Read on...