Peru's Election and Its Mining Industry

Kopin Tan wrote Messy Mañana for Miners (subscription required) in Barron's Magazine.

One of my key stock holdings Pan American Silver Corp. was featured in the story as a company that has the potential to be adversely affected by the nationalistic tendencies in South America, and Peru in particular.

Nationalism is to South America what eyebrow-shaping is to men -- a troubling recent trend -- and Venezuela and Bolivia have already pushed to reclaim oil-and-gas assets. Peru is the world's second-biggest producer of silver, third-biggest producer of zinc and fourth-biggest producer of copper; it accounts for 40% of sales at Denver-based Newmont Mining (ticker: NEM) and about 67% of sales at Pan American Silver (PAAS).

No surprise, then, to see increased hedging of stocks with Peruvian exposure, though some likely has been driven as well by the recent pullback in metals stocks. Option prices and projected volatility have risen noticeably in Newmont, Pan American, Barrick Gold (ABX) and Southern Copper (PCU). In Newmont's case, for instance, traders have accumulated 0.94 puts for every call outstanding, the highest ratio in a year.

Potential fallout may prove less than election rhetoric suggests, and even Señors Garcia and Humala both must realize the importance of foreign investment. But analysts at the very least expect international mining companies to owe increased royalties and face greater pressure to share more of their profits. Nor should short-term risks be underestimated, as news headlines and post-election chest-thumping could keep stocks volatile.

I have been surprised by the low valuation given to Pan American in light of the still strong silver price at nearly $13 per ounce. But uncertainty does take a toll on valuation.

As the article suggests, some might have shorted Pan American with a long in iShares Silver Trust (SLV). If Peru nationalizes or increases taxes against Pan American Silver and other companies, silver production, in time, would likely be adversely affected and thus silver prices would likely rise. If this situation were to play out, Pan American would go down or stay stable, but iShares Silver Trust should increase.

Given that the leading contender Garcia is not a big fan of Chavez, I am not nearly so certain that he would increase taxes aggressively. And he certainly would not nationalize mining companies. Thus, I think the negativism might be overdone.

As a matter of disclosure, I remain long Pan American Silver shares.