South American Silver Corp.
(SAC � TSX, $1.43)
Electric Metals Everywhere

Introduction � Electric Metals Everywhere

Some are going to wonder why we would care about a company called South American Silver. And the answer is that we view silver as an electric metal, one that is of direct interest to us at Byron. We have published a comprehensive argument ("Silver and Tin � The Demand is Electric, the Need is Critical," 29 February 2012), but most readers will understand that Ag prices are supported both by the use of silver as an investment vehicle and ornamental material, as well as by industrial use. For those who have paid attention to Ag only to the extent of noticing that, given the wholesale slaughter of the film industry by digital imaging, the use of Ag in film must have dropped to zero, we have some interesting news. And if this is the extent of analysis done, then it will also surprise those same individuals to find that Ag has an extremely robust and fast-growing demand in the electronics industry.

While true that film use has fallen dramatically, figures from the Silver Institute suggest that the decline in annual Ag use in film is slowing. In the meantime, the financial industry appears to have largely missed a new and rapidly growing demand for Ag in electrical solders. The RoHS (Reduction of Hazardous Substances) directive adopted by the E.U. to exclude materials like lead (Pb) from solder have caused a dramatic increase in industrial demand for Ag. In the past, solder used in the electronics industry was composed of an alloy containing 63% tin (Sn) and 37% Pb. This mixture was used for two reasons, one being its relatively low melting point, which allowed solder joints to be made with delicate electronic components without undue risk of damage.

The other reason is more technical. The old 63/37 mixture of Sn and Pb was what was termed eutectic, meaning that all the components of the alloy melted at the same temperature. In high-speed electronics manufacturing, this is important because the solder is applied and the parts are then moved down the manufacturing line rapidly. If the solder alloy were to contain materials that melted at different temperatures, it is possible that the solder bumps (or joints) on a circuit board might become segregated, with some metals at a higher concentration in one portion of a solder bump than another. This can lead to cracking of the solder joint and an undesirable warranty claim. One of a very small number of solder alloys that is eutectic without containing Pb, and part of an even smaller group with a reasonably low melting point, is an alloy containing Sn, Ag and Cu. Additionally, very small amounts of manganese (Mn) or zinc (Zn) can sometimes be used to help lower the melting point of this alloy further.

Our conclusion is that, at present, with roughly two-thirds of electronics manufacturers using Sn-3.5Ag-Cu solders, we believe that the use of Ag in the electronics industry represented some 110 million ounces per year in 2011, roughly 14% of the global mine production level of Ag of 778 million ounces. And with a long-term annual growth in demand of 7% for electronics, anticipated by such firms as iSuppli, this would see electronic solder demand for Ag growing by 7 � 10 million ounces annually. Adding in growth in demand from solar photovoltaic modules, and the long-term 2% CAGR in mined Ag production is insufficient.

We had previously always assumed that "silver bugs" and currency hedgers were the primary drivers for recently appreciating Ag prices. Now, we admit that this supposition was likely wrong, that industrial demand is likely contributing strongly to Ag price appreciation. Nor do we see many options for that increase to slacken; while increasing Ag prices do put upward pressure on solder prices, one should note that the use of solder in, say, a cellular telephone handset is probably well under 10 grams, making Ag use less than 0.35 grams, or less than 0.01 Troy ounces. For most OEMs, this will either be undetectable for a time or is a cost that can quite easily be passed on to customers.

Similarly, our macro view on Cu is positive. Cu use is likely to increase due to the continuing emphasis on infrastructure advancement in China and India, as well as our conjecture that increasing use of plug-in hybrid electric vehicles (PHEVs) and fully-electric vehicles (FEVs) in the developed world will necessitate reinforcing the grid, especially into areas such as suburbs where drivers will be plugging their vehicles in for the night.

Indium demand is driven most largely by its use in the ITO (indium tin oxide) top conductor used in liquid crystal display (LCD) screen production. ITO is the best, by a wide margin, of a very few transparent or semi-transparent electrical conductors. ITO is not a terrific conductor of electricity, but all the other options are largely abysmal by comparison, and especially for large LCD screens where good conductivity of electrical signals to the extremes of the screen is mandated by the desire for higher frame rates and the like, ITO is an absolute imperative. World production of refined In is only perhaps as much as 576 tonnes per year (according to the USGS). Recycling does introduce additional material, but as with most metals the use of recycling is highest when prices are high, and cannot be relied on as a supply source.

Ga is even less common. Only perhaps 100 tonnes of Ga are produced as a secondary metal from aluminum refining (according to the USGS), with a lesser amount being produced from scrap recycling. Ga has its greatest value in the electronics industry, where it forms an integral part of the chemical compound making up the substrates for some important components used in microwave and infrared electronics, and in LEDs and lasers. Small amounts are used per circuit, but the large volume results in sizeable demand. And the price of Ga is very inelastic; a small decrease in the price of Ga would likely result in a fairly large increase in use, as the superiority of circuits dependent on the supply of Ga, at a slightly lower price, result in higher market share.

It should probably be considered fortunate that one company has accumulated a pair of deposits and the technology required to produce all of the above materials: Ag, Cu, In and Ga. Malku Khota and processing by acid-chloride leaching yields a high level of Ag, owing to average grades of 33.6 g/t Ag, 7.4 g/t In and 4.0 g/t Ga, along with meaningful quantities of Pb and Zn. Escalones is host to a very large Cu porphyry deposit, some 3.8 billion pounds of Cu contained in an inferred 420 million tonnes of ore, grading approximately 0.44% Cu, along with meaningful quantities of Au, Ag and Mo.

We will briefly discuss the process to be employed at Malku Khota, along with the likely process at Escalones. The capital and operating costs, either established by the Malku Khota PEA or extrapolated from similar operations in the case of Escalones, will enable us to complete a DCF analysis for each project, and the sum of the value of the two projects will represent our target value for the company.

Malku Khota � Silver Linings for the Electronics Industry

Introduction
Malku Khota is SOAM's advanced development project in the plateaus of Bolivia. The closest city is Chochabama, 85 km away by road. Malku Khota is a sediment hosted, oxide deposit containing a very large quantity of heap leachable Ag. Along with its Ag, Malku Khota would be one of the world's largest deposits of In and Ga, and would also produce modest amounts of Cu, Pb and Zn.

Unique Flowsheet
If a conventional cyanide leach were employed, which is entirely feasible, then the Ag and Au content alone make Malku Khota a perfectly respectable project. However, the PEA published on May 10 of last year clearly established that the use of an acid-chloride leach, allowing for the recovery of the rare electric metals In and Ga, provides superior economics.

The hydrochloric acid-chloride leach utilizes a leaching fluid containing hydrochloric acid (HCl), sodium salt (NaCl) and hypochlorite (probably sodium hypochlorite, NaOCl). This fluid has high levels of extraction for Ag, but also for In and Ga. The leaching solution coming from the leach pads, after being circulated through mounds of crushed ore, has a large amount of HCl extracted and returned to the leaching process using commercial ion exchange equipment. The remaining solution, pregnant with metals, is then processed, first by "cementing" precious metals and any Cu onto scrap iron that substitutes more soluble Fe ions into the solution, and then by adding sodium hydroxide (NaOH) and precipitating out insoluble In and Ga hydroxides. Further refining is necessary for all of the metals at this stage.

The average grades at Malku Khota are shown in the exhibit below. Along with those are the recovery levels for each of the two different process routes, and the required capital and operating expenses to achieve those recoveries, as estimated within the PEA.

The math for the two cases is inescapable. Given that the effective price of In and Ga in the base case analysis within the SOAM PEA is almost $17 per Troy ounce, with grades that total one-third the amount of Ag, the higher recovery levels and the much higher revenues carry the day. The total operational expense of the project must also include a mining cost, estimated within the PEA at $1.08/tonne of ore.

Country Risk
One of the questions for investors is SOAM's ability to successfully operate in Bolivia. Clearly, SOAM is not the only foreign mining company in Bolivia. Indeed, there have been three major mines built in the country, under the current administration, in the past four years, including projects belonging to Sumitomo, Coeur d'Alene and Pan American Silver. One of the largest mines in the nation is San Crist�bal, the world's third largest primary silver mine and sixth largest zinc mine, a 50,000 tpd Ag/Zn/Pb open-pit mine, operated by Sumitomo. Coeur d'Alene's San Bartolome mine is the second largest mining operation in its portfolio. In addition, there are several very large scale mines being built, as well as several international mining ventures under examination for establishment within Bolivia. For example, a MoU signed last year between KORES and the Bolivia Mining Corporation is structured to allow South Korean firms to be involved in the development of Salar de Uyuni, one of the world's largest undeveloped potential lithium projects. In addition, Jindal Steel is investing $2.1 billion into a very large iron ore project.

Bolivia is heavily dependent on the mining industry, its second-largest economic sector after oil and gas. SOAM is not alone in its interest in the mineral resources of Bolivia, and the Morales government has been actively encouraging private investment into mining, over the past six years, as a way to build Bolivia's economy and address the fact that more than half of the nation's people live in poverty. Recent bond upgrades by both Moody's and Fitch Ratings, based on economic policies and growth, reduced political uncertainty and new anti-corruption initiatives, appear positive. With Bolivia's entry into the MERCOSUR regional trade organization, with Brazil as its largest regional trading partner, and with increased overall trade with Japan, Korea and China, Bolivia appears to be an increasingly favourable emerging resource market for foreign investment.

Escalones � Lots of Copper

The Escalones deposit in Chile is a very large Cu resource. The deposit is located 100 km northeast of Santiago, and 35 km almost exactly due east of El Teniente, Codelco's largest Cu mine and likely the largest underground Cu mine on Earth. The company's current 43-101 resource indicates that the deposit contains as much as 420 million tonnes of ore grading 0.44% Cu, with reasonable amounts of molybdenum (Mo), Au and Ag, as well. For our purposes, we will value any potential mine at Escalones on the basis of Cu, alone.

The site is blessed with good existing infrastructure, including road access and a natural gas pipeline across the property. The project sits just east of the mining and smelting complex at El Teniente, providing a number of development options for the project.

By far, the most encouraging aspect of this deposit is its sheer size. The grade and the nature of the porphyry deposit strongly suggest that this relatively shallow deposit will be economical. The initial deposit size of 3.8 billion pounds of Cu mean that even large-scale production from the deposit by a global major mining company could result in this site being exploited for decades. We expect that the company's current drill program will expand the resource at Escalones, and anticipate a PEA will be delivered before year end.

Management � Strong and Experienced

In this case, there is no need to gild a lily. SOAM is run by an experienced and strong management team.

Greg Johnson � President, CEO and Director: Mr. Johnson became a Director of SOAM in 2009, and was appointed President and CEO in April 2010. An exploration geologist with more than 25 years of experience in the mining industry, Mr. Johnson was a co-founder of NovaGold Resources and during his 12-year tenure there, he had a key role as part of the management team that grew NovaGold from a market capitalization of $50 million to more than $2 billion. While at NovaGold, Mr. Johnson was prominently involved with the acquisition and advancement of three world-class deposits, and the completion of three feasibility studies. He was a co-winner of the Thayler Lindsay International Discovery Award for his role in the discovery and advancement of the 40-million-ounce Donlin Creek gold deposit in Alaska. Mr. Johnson began his career with Barrick Gold where he worked in the U.S. and International Exploration Groups, with responsibility for projects from early discovery stage to development and operations. He holds a B.Sc. (Honours) degree in geology from Western Washington University.

Ralph Fitch � Executive Chairman: Mr. Fitch is an exploration geologist with over 40 years of international exploration, management and field experience. He is one of the co-founders of SOAM, and has founded or co-founded several other exploration companies. Mr. Fitch was Chief Geologist and Manager of U.S. Exploration for the Chevron Minerals Group. His extensive exploration experience includes work in South America, Australia, West Africa, South Africa and the U.S. Mr. Fitch is credited with a number of major international discoveries and was awarded the Chevron Chairman's Award.

Phillip Brodie-Hall � COO: Mr. Brodie-Hall is a professional engineer who brings over 35 years of engineering construction and project development experience to SOAM. His career has spanned nearly every aspect of evaluation, feasibility studies and project development in the mining and mineral processing industries. Prior to his role at SOAM, Mr. Brodie-Hall was a senior Executive with the Bateman Engineering group in Australia, a leading global mining engineering service firm, where he had first-hand experience on challenging projects in Australia, Southeast Asia, Africa, the Middle-East, Eurasia, North America and South America.

William Filtness � CFO: Mr. Filtness is a Chartered Accountant who has been involved in the mining industry for over 25 years as a director or officer of a number of public companies. Mr. Filtness has served as CFO of SOAM since the company's IPO in 2007.

James Mallory � VP, Operations and Social Responsibility: Mr. Mallory brings over 30 years of mining industry experience to SOAM, in large-scale mine management, operations and construction in both North and South America. Most recently, he was VP with Silver Standard Resources, working on the start-up of the Pirquitas silver mine in Argentina, as well as at other advanced development projects in Peru and Mexico. Prior to that Mr. Mallory held management positions with responsibility for operations and sustainable development with Barrick Gold (Placer Dome) and NovaGold.

Felipe Malbran � VP, Exploration: Mr. Malbran brings over 25 years of exploration industry experience to SOAM, and has served as VP, Exploration for SOAM since its IPO in 2007. Mr. Malbran has been involved in a number of major mineral discoveries, including Malku Khota, Escalones and Vizcachitas. His career has included exploration for precious and base metal deposits throughout Latin America, while working with firms including Teck Cominco, General Minerals and Geoestudios Consultants. Mr. Malbran holds a geology degree from the University of Chile, and is a QP for SOAM.

David Dreisinger � VP, Metallurgy: Dr. Dreisinger has been working as a metallurgical consultant with the company since May 2006. In addition, he currently holds the position of Professor and the Industrial Research Chair in Hydrometallurgy at the University of British Columbia. Dr. Dreisinger, with co-workers, has been actively involved in developing and commercializing hydrometallurgical technology such as the Mt. Gordon and Sepon copper processes in Australia and Laos. Through the Industrial Research Chair in Hydrometallurgy, he is actively engaged in both research and the teaching of technical short courses to the global metallurgical industry. Dr. Dreisinger also serves as a Director of PolyMet Mining Corp. and International Nickel Ventures Corporation.

Andrew Clark � Manager of Project Implementation: Mr. Clark has over 30 years of experience in the design and management of industrial, mining, materials handling, chemical and petrochemical projects. These projects have ranged from feasibility studies through to the commissioning and handover of completed facilities. He has held a number of senior management roles during his career, and has extensive international experience as a project manager on projects located in Africa, Australia, the Middle East, Eurasia, and both North and South America.

Xavier Gonzales Yutronic � GM Compa��a Minera Malku Khota S.A.: Mr. Gonzales has over 20 years of industry experience in the mining industry, encompassing the areas of finance, logistics and community relations while serving with Comsur S.A. (one of the largest mining companies in Bolivia), Glencore (Sinchi Wayra) and Compa��a Minera Malku Khota. Mr. Gonzales has been part of the successful development of many projects and mining operations with the Bolivian Departments of Oruro, Potosi and Santa Cruz, and he holds a business administration degree from the Catholic University of La Paz.

Valuation � Electric Metals, Electrified

It should surprise no one that we are interested in Cu, as Cu is, fundamentally, the principal electric metal. Cu is the conducting metal of choice in practically every application, from grid conductors to motor and generator windings to wiring within homes, electrical and electronic devices, including automobiles. In fact, we have heard it said, by Yucong Wang of General Motors, that while it is entirely possible to build a hybrid or electric car without rare earth elements (although he noted that he was unsure just how good a product omitting REEs would yield), building any car without Cu poses serious issues. While Ag conducts electricity better than Cu, it is simply too expensive, and aluminum has demonstrated significant long-term performance problems when used as a grid, or even household, conductor.

Perhaps a greater surprise is our interest in Ag. Until only five to six years ago, Ag would not have been considered a major electric metal. Now, with its use as a significant ingredient in RoHS-compliant solders in the electronics and electrical industries, Ag cannot be ignored.

Because of the growth in demand for both Cu and Ag as China and India continue to grow, as electric transport gains market share globally, and as electronics continues along its inexorable growth curve, we are perhaps more bullish than most regarding our price deck for both Cu and Ag. We will shortly publish our views on each of the industries, but it is our belief that both will maintain higher prices into the indefinite future, as industrial use helps to grow the price of Ag while growing international demand potentially moves Cu into a position of undersupply.

For the purposes of valuing SOAM, and allowing for an apples-to-apples comparison with projects as evaluated by other brokerages, we will use a long-term Cu price of $2.95/lb ($6,500/tonne), and a long-term silver price of $25/ounce. Our prices for In and Ga, per kilogram, are $600 and $500, respectively, supported by growing demand in electronics and LCDs. However, we will note what the valuation of Malku Khota would be if we use our long-term price deck for Ag, driven by demand increases for Ag in electronic solder and in photovoltaics.

We choose to use a discount rate of 17% for Malku Khota, primarily due to the location of the project within Bolivia. The discount factor we apply to Escalones is 13%, driven primarily by the earlier stage of the project and its location in Chile. Our assumptions are that Malku Khota can come into production in 2016, but that Escalones will not reach production until 2018. Both projects are valued on their primary products only, so Escalones is valued solely on the basis of its Cu production, while Malku Khota is valued for its Ag, In and Ga.

We assume that Malku Khota is a 40,000 tpd open-pit mining operation, with mining costs of $1.08/tonne, and processing costs of $6.41/tonne (as per the SOAM PEA regarding the deposit). Capital costs at Malku Khota total $550 million, with annual sustaining costs of just over $50 million. Our terminal multiple, taking into account the remaining value in the project at the end of 2020, is 10x. Per all the above, our NPV for Malku Khota is $196 million.

For Escalones, there is obviously less available information. However, we assume that Escalones will be a 50,000 tpd mining operation, with mining costs of $1.50/tonne and processing costs of $6.00/tonne of ore (both values based on published costs of other Cu projects in South America). Capital costs are, we assume, significantly higher than those for Malku Khota, as much as $1.3 billion, and that the project will require sustaining investment of just over $60 million per year. With a terminal multiple of 10x in 2020, based on its large deposit size, the NPV for Escalones is some $161 million, at present.

Taking into account the cash balance and value of in-the-money options and warrants, our fully diluted value for the company is $396 million. We recognize that some investors will place significantly different strategic values on the different materials being produced by the company, and so we apply a "holding company" discount of 12% to our calculated value, giving us a $2.95 NPV/sh. We will thus establish a target price of $2.75, and we are therefore initiating coverage with a SPECULATIVE BUY rating.

For informational purposes, we also valued Malku Khota using our own long-term price deck for Ag (published in our report "Silver and Tin: The Demand is Electric, the Need is Critical"). In this case, the relevant prices from 2016 to 2020 start at $57/oz, climb to $69/oz in 2018, and we assume they will stay flat into the future. Using all the same parameters as above, the valuation of Malku Khota climbs from $196 million to $1,771 million, and the discounted value for SOAM would be almost $15.00.

Conclusion � Electric Metals Everywhere

SOAM is one of the most interesting mining juniors we have come across. There are very few companies that have deposits containing so much of some of the electric metals that we view as being in shortest long-term supply. Management is solid and experienced, and is entirely capable of continuing to build the team that can bring a combined series of projects requiring some $2 billion in capital expenditures to production. We are very bullish on the future of both Ag and Cu pricing, and we agree with a number of independent assessments that In and Ga are critical electric metals with good pricing futures ahead of them, as well. For us, the electric metal content of Malku Khota and Escalones more than warrant a target price of $2.75, and we are initiating coverage with a SPECULATIVE BUY rating.

View "Exhibit 3 � Valuation of South American Silver"

� 2012 All Rights Reserved.. Natural Resource Investor & World Gold Stock Report is a client-sponsored publication and South American Silver Corp. pays monthly fees to a related public relations firm for this communications service. The company has paid expenses of $2,250 for the dissemination of this report. Safe harbor provisions apply as per the company's website.