On the surface, the bearish case against McEwen Mining (MUX) seems cut and dry. Yes, gold has been a strong performer, generating excitement across the resource ecosystem. However, McEwen — which focuses on gold and silver exploration — is speculative, carrying a market capitalization of less than $500 million. Not surprisingly, MUX stock features a beta of 1.42, indicating higher volatility than the benchmark equities index.
At first blush, circumstances appeared rather auspicious for McEwen. Last week, management announced a gold resource increase at its Fox Complex mining project’s Grey Fox deposit. Indeed, the bump up was of a significant magnitude compared to the company’s 2021 estimate. The key takeaways from the press release are below:
- Indicated gold resources grew by 32%, standing now at 1.54 million ounces.
- Inferred gold resources popped by 95%, clocking in now at 458,000 ounces.
- These increases stem from a combination of exploration drilling, higher gold prices and a lower cut-off grade.
- Further, the company reported a discovery cost of $14.46 per ounce, which is efficient for a gold miner.
- Management disclosed drilling optimization which has helped identify multiple gold lenses with each drill hole.
Ultimately, one of the biggest takeaways from the announcement is that the Grey Fox deposit could be a strong future gold producer. There are over 150 distinct mineralized lenses identified in a compact 1.4-kilometer area and some of the veins start from the surface and extend over 800 meters deep. This observation suggests a robust gold system.
So, the question of the hour: why was the market spooked on Friday? It had to do with stock dilution concerns.
At the end of last week, McEwen announced the pricing of its upsized offering of $95 million of convertible senior notes. Such actions are typically dilutive, especially in the near term. Therefore, it would seem that the market panicked — without really considering the fine print.
Dilution Risks for MUX Stock Not Nearly as Bad as Initially Feared
Thanks to the heavy activity on MUX stock, it represented a highlight in Barchart’s unusual stock options volume screener. On the surface, the numbers don’t seem to tell a flattering tale.
Following Friday’s closing bell, total options volume for MUX stock hit 9,067 contracts against an open interest reading of 25,149 contracts. Relative to its trailing one-month average metric, Friday’s volume shot up 959.23%. What may have worried onlookers is that call volume only tallied 3,625 contracts, while put volume clocked in at 5,442 contracts. This pairing yielded a put/call volume ratio of 1.5, which seems unsightly.
However, it’s important to look at the fine print and analyze it carefully. At last week’s end, options flow — which focuses exclusively on big block transactions likely placed by institutional investors — reached $142,700, strongly favoring the bulls. Therefore, at least some of those puts were likely sold, which is indicative of a neutral to slightly bullish posture.
While the options flow data is important to acknowledge, that’s not the crux of the argument for MUX stock. Rather, it’s this detail in the PR disclosing the convertible senior notes:
Separate capped call transactions have the potential to synthetically increase the effective conversion price for conversions at maturity to $17.30 per share, which represents a 100% premium to the closing sale price of the Company’s common stock on February 6, 2025.
Now, I don’t want to dive into the weeds regarding all the intricate details associated with capped calls, which are complex financial vehicles. However, the short story is that capped calls are derivative hedges that companies deploy to reduce dilution from convertible notes. Basically, it’s an options strategy that allows management to buy back shares at a higher price, minimizing the impact of conversion on existing shareholders.
In this case, the capped calls likely allowed McEwen to negotiate a higher conversion price. This provides a buffer before dilution becomes a real threat.
It's possible — though difficult to say with certainty — that retail investors didn’t quite understand the capped call nuance and instead knee-jerk reacted to the dilution risk (which, while real, could have been worse without the negotiated finance deal). However, that the open market saw bearish activity while the options market saw bullish positioning seems to suggest that the regular Joe and Jane shot first and decided to ask questions later.
Negative Bias Presents a Question Mark
Before you get too excited about a potential 500-IQ contrarian opportunity, you should be aware that MUX stock features a negative bias. Using data over the past five years from a stochastic view (that is, devoid of any other context aside from the temporal), a position entered at the beginning of the week has a 44.19% chance of rising by the end of it.
Over a four-week period, the long position success ratio rises slightly to 46.15%. That’s still worse than a coin toss, which makes the proposition natively poor.
Under dynamic conditions (a Bayesian approach), the situation worsens. Last week, MUX stock lost 10.33%. Whenever MUX loses 10% of value or more in a one-week period, the subsequent week rises only 45.45% of the time. Over the next four weeks, the success ratio dips sharply to 31.82%.
The thing about this framework, though, is that under the rare positive scenario, the median return stands at 15.09%. Under the negative scenario, the median loss is only 9.53%. Therefore, the magnitude of upside in going contrarian (and being right) is far greater than betting on MUX’s statistical tendencies.
It’s going to be an agonizingly difficult decision. However, the very real possibility that the market could be making a mistake makes MUX stock awfully tempting.
