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It’s hard to believe that silver was trading at
only $4 just 11 years ago. And amazingly it was only 7 years ago that silver
had hit $10 for the first time in nearly two decades. Now at over $30 and
rising, silver is flexing its muscles as one of the best-performing assets of
the last decade.
There’s no arguing that silver’s secular
bull has been spectacular. Since its 2001 low, silver had soared a staggering
1094%
to its 2011 high. And based on its structural fundamentals, silver’s
bull still likely has plenty of room to run in the years to come.
Investors who’ve been accumulating this precious
metal over the years (like our newsletter subscribers who first started
buying with us when we officially recommended it as a long-term investment
back in 2001) have obviously fared quite nicely. But there’s another
silver vehicle that in some cases has fared even better. Silver stocks,
leveraged plays on the underlying metal, have had quite the bull market of
their own.
Though there is no silver-stock index that has a
long-enough history to give us a direct comparable to silver over the course
of this bull, the next-best comparable is the performance of gold stocks
given their tight correlations. And the venerable HUI gold-stock index is
probably the most conservative metric (the HUI is comprised of the
world’s largest gold stocks, along with a couple of large silver
stocks).
Considering their risks, mining stocks should exhibit
positive leverage to the metals. And with a bull-to-date gain of 1664%
to its 2011 high, the HUI has indeed easily outperformed its underlying metal
(+640%). And I suspect a primary silver-stock index would have gains just as
good, if not better, over this time.
Thankfully there’s a product that has come to
market recently that does offer investors some semblance of sector-level
performance for silver stocks, the Global X Silver Miners ETF (SIL). Global X
Funds has been a huge innovator in the ETF realm in recent years, especially
when it comes to commodities stocks. Its unique approach gives investors easy
access to small commodities sectors and subsectors. And the first-of-its-kind
Silver Miners ETF is a godsend to the tiny silver-stock sector.
SIL was conceived in April 2010, and like all ETFs its
goal is to closely mirror the performance of an underlying index. This index
is the Solactive Global Silver Miners Index, and it
is designed to generally reflect the performance of the silver-mining
industry. SIL is ultimately comprised of stocks that are actively engaged in
some aspect of this industry whether it be
mining, refining, or exploration.
I see two major benefits to this ETF, and the first is
the overall benefit offered to investors. As with most ETFs, SIL is easy to
buy, easy to sell, and it
even has a relatively liquid options market. SIL’s basket of silver
stocks also greatly reduces individual-company risk. And it even offers
geographical diversification, which is a big deal in the mining industry.
SIL also opens up the opportunity for institutional
investment. Since most individual silver stocks rank too small and/or
illiquid for institutional guidelines, most institutions couldn’t or
wouldn’t touch them. With the advent of SIL, many can and hopefully
will as this ETF grows in popularity (SIL’s total assets are currently
about $366m).
Many folks, especially ETF haters, may look past these
obvious investor benefits. But they shouldn’t! Since silver stocks are
small by market capitalization, thin in population, tend to be illiquid, and
are known to be hyper-volatile, they can be very intimidating to potential
investors who aren’t attuned to the industry. I guarantee you that a
big chunk of the capital pouring into this ETF wouldn’t have found its
way to silver stocks otherwise if it didn’t exist.
The second major benefit of this ETF piggybacks off the
first. And that is capital shunting directly into the underlying component
mining companies. This may not seem like a big deal, but considering the size
of these stocks, any buying is good buying. This increases exposure,
liquidity, and ultimately the stock prices in a strong silver environment.
Speaking of strong silver environment, this is exactly
what investors rely upon in order for silver stocks to move to the upside.
And as most folks who are interested in this sector are likely aware, silver
is in the midst of a strong
new upleg. Since its
late-June low, silver is up an impressive 32% to its high just last week.
This new silver upleg gives
us an excellent chance to test the resolve of the SIL ETF. And with a 48%
gain since its own low in July not only has SIL kept up with silver, it has
indeed provided the positive leverage that is essential to keeping investors
interested in these types of stocks.
Returns like this over only about two months are
certainly attractive. And this will no doubt draw increased attention to
silver stocks. And for many of the first-timers into this realm, the SIL ETF
will be their first destination for capital.
These returns of course piqued my own interest, which
prompted me to do a little dissecting. It’s always prudent to get more
intimate with an ETF than just its name, to find out if it truly is the best
proxy for a given sector. Even a high-level peek can speak volumes.
In the table above you’ll find a summary of
SIL’s holdings, ranked by percentage of assets in descending order. In
blue are the stock symbols, followed by the market capitalizations in US
dollars, and then the stocks’ flagship project location(s).
In total SIL is comprised of 32 component stocks, which
is actually a significant portion of the world’s population of silver
stocks. By our count, there are less than 125 primary silver stocks
(explorers, developers, and producers) with listings on the US and Canadian
exchanges. And it is well known that these exchanges are host to the vast
majority of resource stocks.
To put this listing concentration in context, of the 32
SIL holdings all but 5 have primary listings in the US and/or Canada. While
there are a handful of silver companies that list their stocks exclusively in
London, Mexico, Australia, or elsewhere, it is a minority. I’d say that
SIL’s 85% weighting towards US and Canada stocks is a fair
representation of the global concentration of silver stocks.
Even if we are conservative and say there are 150
primary silver stocks in all the
world, this is still an incredibly small number. You’d think
there’d be more companies scouring the planet for this precious metal,
especially considering its fortunes over the last decade or so! There are
however logical reasons for this phenomenon, the most prevalent being silver’s geological nature.
Interestingly as measured by revenue, silver is usually
a byproduct
of polymetallic deposits that hold strong
concentrations of either base metals (typically lead and zinc) or gold. For
this reason less than one third of total global mined silver
production comes from primary silver mines. And because of
this, mining companies that explore for and successfully develop primary
silver deposits are not as common.
Another attribute that comes with primary silver stocks
is their generally small size. The simple average market capitalization of
the 32 SIL components is only $2.6b. And if I exclude its big four, the
average goes way down to $873m. This is definitely small-cap territory to say
the least. And there are a few main reasons for their pint-sized statures.
The first reason is simply the lower relative value of
primary silver deposits and/or operations. In general a large
silver deposit contains resources in the neighborhood of 40m ounces, with a very large
mining operation producing 4m ounces per year. Compared to gold (at the
current 1-to-52 ratio), a large silver deposit is equivalent in value to a moderately-sized
gold deposit (769k ounces). And a very large silver-mining operation is
equivalent in value to a small gold-mining operation (77k
ounces).
Another reason for the generally small size of silver
stocks as a group is the lack of producers. There is naturally a big drop-off
in market cap from producer to explorer since there is no guarantee that a
deposit will ever be developed into a profitable mine. Amazingly there are less than 30
publically-listed primary silver producers in the world. And SIL holds nearly
all of them, with three-quarters of its components actively mining the
shiny-white metal.
Lastly we can attribute silver stocks’ small size
to the fact that many of them are woefully undervalued. There are a myriad of
fundamental and technical reasons supporting this assertion. But in general
this sector is still greatly lacking in the exposure it deserves considering
the performance to date and future promise of its underlying asset.
As for SIL’s percentage of assets, the weightings
clearly heavily favor the larger-market-cap companies. Nowhere in its
prospectus can I find a reference to a strict adherence to the conventional
weighted-average market-capitalization formula that most indices employ, but
I assume its custodians run some kind of a hybrid formula along those lines
judging by the weightings.
As you can see, SIL’s largest three holdings
combine for 36%+ of its total weighting. Silver Wheaton (SLW) is SIL’s
largest holding, and it of course lists on both the NYSE and TSX. Known as a
streaming company, SLW is somewhat of a hybrid between a royalty company and
a producer. I’ve long held the stance that its brilliant business model
makes it the perfect silver stock. SLW is thus the perfect
company to anchor this fund!
SIL’s next two largest holdings are Mexican-based
companies that actually don’t carry big-board listings in the US or
Canada. And they have quite an interesting interrelationship. Fresnillo PLC (FRES, listed in London) ranks as the
world’s largest primary silver producer, with the lion’s share of
its volume coming from its massive namesake mine (30m+ ounces per annum) in
Zacatecas.
Industrias Peñoles
(PE&OLES, listed in Mexico) is more of a conglomerate company that sports
a broadly diversified portfolio of operations. Peñoles has its hands
in a wide variety of metals mining, and also operates a robust downstream
business (smelting, refining, marketing, etc…). In fact, the only
reason Peñoles
is considered a silver company is because of its 77% ownership of Fresnillo (Peñoles spun off Fresnillo
in 2008).
As you go down the list, the next 13 stocks combine to
account for 55% of SIL’s weighting. And this brings the total weighting
of the top half of its holdings to 91%. It is quite clear that this ETF
adheres to some sort of market-cap-weighted structure.
Of these 13 stocks there’s a good mix of mid-tier
and major producers, along with a high-quality junior. On the producer front
Pan American Silver (PAAS), Coeur d’Alene Mines (CDE), and Hochschild Mining (HOC, listed in London) are among the
rare 10m+ ounce primary silver producers. And then we see First Majestic
Silver (AG), Hecla Mining (HL), Silver Standard (SSRI), Silvercorp
(SVM), and Endeavour Silver (EXK) as primary silver miners producing in the
neighborhood of 5m to 9m ounces annually.
In this group we also find Polymetal
International (POLY, listed in London) and McEwen Mining (MUX). And
interestingly these companies tout themselves as primary gold
producers. POLY does own the third-largest primary silver mine in the world
(the Dukat mine in Russia),
but it is just one spoke on a wheel that is mainly filled with gold mines.
And while MUX’s current operation in Argentina slightly favors silver
over gold measured by revenue, it is in the process of developing a
gold-centric portfolio.
Lastly in this group of 13 is the lone junior, Tahoe
Resources (TAHO). Looking at its market cap, you wouldn’t think this
company was a junior. And it only is in the sense that it hasn’t yet
produced any silver. But it will soon be a major producer once its massive under-development
high-grade mine in Guatemala achieves commercial production in early 2014.
As for SIL’s remaining 16 stocks, they
cumulatively account for only about 9% of its total assets. These smaller
stocks have an average market cap of just under $200m, which ranks in the
micro-cap category by definition. And of this group 10 are smaller producers
and 6 are explorers.
Overall after a quick run-through of its holdings,
I’d say that the SIL Silver Miners ETF is a fantastic vehicle for
gaining exposure to silver stocks. And I would highly recommend it to
investors who are either just getting to know this sector and/or have no
interest in owning individual stocks.
But for investors who do have a bit higher risk
tolerance and are willing to learn, individual stock picking is where the
real gains are at. If a large basket of stocks heavily weighted to the
biggies is capable of positively leveraging silver’s performance,
imagine what a smaller skillfully-selected portfolio of stocks can do!
At Zeal we specialize in stock research, and silver
stocks happen to be one of our niches. We recently completed a 3-month
deep-research project looking at the universe of silver stocks trading in the
US and Canada, and narrowed them down to our 12 fundamental favorites. These dozen
stocks range from smaller juniors to the world’s premier producers, and
are profiled in depth in our hot-off-the-presses 29-page report. Buy yours today!
We’ve been buying some of these stocks in our
acclaimed weekly and monthly newsletters over
the last couple months. And so far some of our open positions have unrealized
gains exceeding SIL’s best as of this week. There’s still likely
a lot of room to run for these stocks as silver’s upleg
gains strength. If you’re interested in finding out which stocks
we’re buying in our newsletters, subscribe today!
The bottom line is investors who’ve been buying
the companies that explore for, develop, and mine primary silver deposits
have been greatly rewarded over the course of silver’s secular bull.
And thanks to the recent addition of the SIL Silver Miners ETF, this sector
is able to reach investors on an entirely new level.
After taking a closer look at SIL, a case can be made
that this ETF represents an excellent proxy for this high-risk high-reward
sector. And as a new wave of investors find their way to silver stocks, SIL will be waiting with
open arms. But by their nature ETFs have their flaws. And for investors who
seek better leverage than what ETFs have to offer, nothing beats a skillfully-selected
hand-picked portfolio of elite silver stocks.
Scott Wright
September 28, 2012
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