Hunting down deep-value stocks at present may seem like an easy exercise. If I look across various different industries at the moment, there are many shares that have fallen on hard times. Scottish Mortgage Investment Trust, Ocado, boohoo and many other growth stocks have fallen significantly over the last six months.
However, just because a stock looks cheap relative to its all-time high share price does not mean that it is necessarily a bargain. Indeed, as I have argued elsewhere, Scottish Mortgage and boohoo still look relatively expensive in the present environment.
Identifying deep-value stocks
The key to identifying which sectors represent the greatest value at the moment, one has to have an appreciation of the wider economic forces that are playing out among developed economies.
For the first time in four decades, inflation is beginning to rear its ugly head. Anybody under the age of 50 will have no real inkling what runaway inflation can mean for the economy, let alone an investor’s portfolio.
Buying the dip, the mantra of retail investors over the last couple of years, has been a profitable strategy to employ. But that was then and this is now.
Today, the cost of capital is beginning to creep up. That matters to companies with bloated balance sheets that have borrowed heavily to fund their growth. It matters to the mega-cap tech stocks in the US that will find it hard to justify their lofty valuations. It also matters to bank stocks too. None of these sectors look cheap to me.
The deep-value opportunity at the moment is in precious metals. Gold is now near an all-time high at over $2,000 an ounce. The last time it reached that price in 2020, gold mining stocks were significantly higher than they are today. If I exclude Polymetal, which is down 90% due to its Russian connections, the likes of Centamin and Hochschild Mining are half the value they were back then.
My top pick
Although gold is flying, its cheaper cousin, silver, has only seen modest rises. At the moment it is trading at $26 an ounce. In the last bull market for precious metals in 2011, gold reached $1,800 and silver, $50. A more comparable set up in relation to today (with high inflation) was 1980. There, silver topped at $50. This implies that silver has some catching up to do.
Fresnillo, (LSE: FRES) the world’s largest primary silver miner is set to benefit from any explosive increase in the price of silver. Its all-in sustaining cost (AISC) for silver for 2021 was $15.6. Given that its total production of silver for the year was 53moz, that helped to contribute to an EBITDA margin of 45%.
Set against these impressive margins, the company is still facing significant headwinds. The labour reforms in Mexico have restricted its ability to subcontract labour. This has resulted in a surge in vacancies and a higher workforce turnover. The ability to attract and retain a highly skilled labour force is absolutely critical to any miner. In addition, wage price inflation is hurting the business too.
However, I remain convinced that the price of silver is heading upward over the coming decade and have been adding to my position in the company while the share price remains at low levels relative to its future growth prospects.
