The Gold Report: Maria, in April Eric Sprott sold more than $45 million ($45M) worth of units in the Sprott Silver Physical Trust. A spokesperson told Canada's Globe and Mail that the sale was needed to cover charitable obligations and to buy shares in silver mining companies because Mr. Sprott believes silver equities will outperform the metal in the next rally. Can you fill in the details on that thesis?
Maria Smirnova: We believe in the equitiesfor any commodityfor several reasons. Equities represent a leverage play on the underlying commodity. To use a simple example: Assume Company X can earn $5 when the silver price is $25/ounce ($25/oz). If the silver price increases 20% to $30, that extra $5 goes directly to the bottom line. This doubles the company's profits from $5 to $10. The silver price increases 20%; the profits rise nearly 100%that is what I call leverage.
In addition, mining companies benefit from production growth through exploration or acquisition. We look for companies that can find millions of ounces of silver or gold.
TGR: Precious metals have certainly had their detractors of late. Why does Sprott Asset Management remain committed to precious metals?
MS: Governments are trying many maneuvers to fix the economic situation, printing money, for example. None of their actions are actually fixing the underlying economic issues. We remain committed to the precious metals because they are hard assets.
In addition, the financial market has become disconnected from the physical market. Especially since April's two-day selloff in silver and gold, purchases of the physical metals have surged.
For example, sales of the U.S. Mint's silver coins jumped 57% year-to-date compared to last year (as of April). Sales increased 169% in April alone. We have heard stories of people lining up to buy silver in Canada and Australia. Demand is up in China as well. Chinese jewelry sales grew 72% in April compared to 2012.
If you look at the exchange-traded funds (ETFs), silver ETFs have not had a large selloff.
The buyers are there, the physical demand is there, but the price is just not reflecting that. It is a bit frustrating, but from my perspective, it is comforting to see the numbers show that people want to own silver and are buying more of it.
TGR: Can you tell us about some of Sprott's top picks?
MS: Earlier this year Mr. Sprott made MAG Silver Corp. (MAG:TSX; MVG:NYSE) his top pick in the silver developer space and Sprott Asset Management took a position worth more than $26M. MAG Silver has a world-class deposit, the world's highest-grade silver development asset right now. MAG Silver owns 44% of the Juanicipio deposit in Mexico.
The grade is between 500 and 700 grams per ton (700 g/t), which is very high grade. The deposit has good thickness, so the economics have the potential for a very profitable mine. It is all about how economic the deposit is.
Fresnillo Plc (FRES:LSE) is MAG Silver's joint venture partner. Fresnillo operates Juanicipio and is pushing the project forward. Fresnillo should do a good job putting this into production and MAG Silver will benefit. MAG Silver is trading at about a 20% discount to net asset value, so this is not a bad time to buy.
TGR: Fresnillo also owns about 17% of MAG Silver. Some market watchers believe Fresnillo will ultimately buy MAG Silver given its ownership stake and the Juanicipio joint venture, but Fresnillo lacks the money to make an all-cash bid. Does that change the investment thesis for MAG?
MS: No, not at all. Fresnillo recently raised about $350M with a company called First Eagle Investment Management. That was done to maintain FTSE free float listing requirements. If Fresnillo does not have enough cash per se, it could do a cash-and-share acquisition.
Even if Fresnillo does not buy Juanicipio, when it goes into production, MAG Silver shareholders will benefit from the 44% stake.
I never invest in companies banking on a takeout. We always look at the basics: the deposits, the management teams, the fundamentals of the projects themselves.
TGR: MAG Silver also has the Cinco de Mayo project. Could MAG sell its 44% stake in Juanicipio to Fresnillo and then focus on Cinco de Mayo?
"No government actions are actually fixing the underlying economic issues. We remain committed to precious metals because they are hard assets."
MS: That could be an option.
TGR: In a recent radio interview, Mr. Sprott said, "The beauty of silver is that there is not much inventory in the world." What other small-cap silver equities are slowly but surely adding to the global silver inventory?
MS: I co-manage the Sprott Silver Equities Class with Eric Sprott and Charles Oliver and have been investing in the smaller silver producers.
We own names like Mandalay Resources Corp. (MND:TSX), SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT) and First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE). All of these companies are growing their silver production.
TGR: One of Mandalay's primary assets, Cerro Bayo, in southern Chile, had operational hiccups as the mine completed its ramp up to 1,200 tons of ore per day. What kind of production are you modeling from Cerro Bayo for the rest of 2013? And what cash-flow-per-share should Cerro Bayo generate?
MS: Cerro Bayo's production dipped a bit in Q1/13, but the reason was to accommodate the installation and commissioning of some new equipment designed to improve metallurgical recoveries, so I do not view the shortfall as negative at all. I expect the company to meet its 2013 overall production guidance despite whatever hiccups it had in Q1. In fact, Mandalay tends to exceed guidance. Management is guiding around 3 million ounces (3 Moz) of silver and 20,000 oz of gold production in 2013. This year, using $24/oz silver, I estimate about $0.16 cash flow per share, which implies that the stock is at about 5.5 times cash flow right now and has a 3.5% dividend yield.
TGR: How does that compare to its peers?
MS: Very favorably. The majors are trading at 1315 times cash flow, using a current silver price, not a high silver price.
TGR: What silver price do you use in your models?
MS: I usually just use the spot price to evaluate all companies. For me, it is a relative-standing game. I do not project the silver price going forward. If today's price is $24/oz, I will use $24; that allows me to evaluate all companies on a fair ground.
TGR: You mentioned First Majestic. As of late March, it was the largest equity holding in the Sprott Canadian Equity Fund. Why does the fund have such a significant position in that name?
"It is very comforting to see retail buyers choosing in droves to own the physical metal. We hope that leads to higher market prices for gold and silver, and in turn to a rally in the stocks."
MS: Our initial investment in First Majestic was at less than $4/share. Today, the stock is $10 or $11/share. The position has grown because of price appreciation, as well as subsequent purchases.
First Majestic is one of the best silver plays out there. The management team has definitely delivered on its promises. The company built five mines and is adding two more. It is one of the purest silver producers out there; 90% of the production is silver.
Management has done well keeping costs under control. The total cash costs are virtually unchanged since 2008 at about $9/oz. Production is still growing. We think the silver equivalent production could double from 2012 to 2014. The stock is trading at about eight times next year's projected cash flow. This is a very reasonable multiple using the current silver price.
TGR: Is First Majestic an example of Sprott's approach to the equities? Even though overall things may not be that great in the sector, some very good performers exist.
MS: Absolutely. To me the key is to find the companies that can survive a tough market, exceed expectations, deliver on their promises and generate free cash flow. That describes First Majestic.
TGR: You mentioned SilverCrest. In Q1/13, SilverCrest sped up removal of waste rock at its Santa Elena mine so it could produce more silver and gold in the summer months when machinery tends to break down more frequently. Is that a typical mine management move?
MS: That decision was prudent. SilverCrest built the Santa Elena mine and has made money in the last couple of years. Now management is deciding to transition the mine from an open-pit to an underground operation. It is building a mill to grow production.
TGR: Where will SilverCrest's production growth come from?
MS: Last year SilverCrest produced about 2.4 Moz silver equivalent, and the target is to grow production to 4.5 Moz silver equivalent. That may not happen next year, but it will get there by 2015.
TGR: Are there any other small-cap names you would like to talk about?
MS: I want to mention International Northair Mines Ltd. (INM:TSX.V) in Mexico. It is small, but interesting, run by an experienced management team. The market cap is $10M, but the company has defined a deposit of more than 50 Moz silver in an open-pit resource. To date, the company has drilled 40% of a 6-kilometer (6km) mineral strike. The deposit is open on both ends and to depth. Two things here appeal to me: There is a lot of potential to find more ounces and the market cap is tiny.
TGR: How would you compare International Northair's La Cigarra deposit with other development-stage silver assets in Mexico?
MS: I like the deposit. The initial metallurgical tests are positiveno red flags. I think the resource could be increased by 50% to 100%. Just drilling the remaining 4km could more than double the resource. I do not see that kind of blue-sky potential in many companies right now.
TGR: Do you have a time frame for when the market might begin to favor precious metals again?
MS: That is hard to predict. A lot of what is taking place right now does not make sense. It is very difficult to predict when things will turn. We take a long-term view.
TGR: A number of the companies we have talked about have operations in Mexico. There has been some talk of increased royalties and some quiet forms of nationalization. Is that a concern at all?
MS: Nationalization is not a concern at all. Regarding royalties, the proposal appears to be for a net profits royalty tax of about 5%. That would equate to a 2% top-line net smelter royalty, lower than what people expected. This is not atypical and it is not a windfall tax. Therefore, in my mind, it will not have a huge impact on these companies.
The removal of the uncertainty about the tax is probably good for the mining industry in Mexico. We will move on and live our lives.
TGR: How do you view the silver space and what is your outlook for small-cap silver miners?
MS: I think you have to remain optimistic that the prices of the commodities, especially silver and gold, turn around. I do not even want to call them commodities, to be honest. I would call them currencies, especially gold. Silver is a hybrid because it also has industrial applications.
Once the turn happens, these stocks could explode in a good sense and completely revalue to the upside. Today, they are at depressed valuations.
TGR: Is there an across-the-board percentage recovery you would predict?
MS: Some stocks are down 50%60%; they could double or triple. First Majestic used to be a $20/share stock; it will go back there and then some based on earnings alone.
TGR: To what do you attribute the two-day fall in mid-April? Was it manipulation?
MS: Yes, I would agree with that characterization. It is very difficult to believe that something could fall that much in just two days. A whopping 1.8 billion ounces of silver was traded on the COMEX on April 12 and 15that's in a 1 billion ounce market!
TGR: And what are the reasons behind the more general mining equity slump?
MS: A lot of people believe we are fixing our economic problems and things are getting better. People are going to the U.S. dollar and to other assets and other sectors.
There have also been disappointments in the mining sector with companies not meeting their guidance and costs coming in higher. This too has put a damper on investor sentiment.
TGR: Can you leave us with a positive thought about the space in general?
MS: It is very comforting to see retail buyers choosing in droves to own the physical metal. We hope that leads to higher market prices for gold and silver, and in turn to a rally in the stocks.
TGR: Maria, thank you for your time and your insights.
Maria Smirnova joined Sprott Asset Management as a research associate in May 2005, and was appointed associate portfolio manager in February 2010. She currently co-manages the Sprott Silver Equities Class with Eric Sprott and Charles Oliver. She is also responsible for supporting the portfolio management team in the precious metals and mining space. Smirnova has over 12 years of experience in the financial services industry; she began her career at Excel Funds Management as operations manager, and subsequently worked in product development at Fidelity Investments. Smirnova graduated with distinction from the University of Toronto with a Bachelor of Commerce degree and obtained her CFA charter in 2002. She graduated as a Bregman Scholar from the University of Toronto's MBA program in 2005.
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1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: International Northair Mines Ltd., MAG Silver Corp., Mandalay Resources Corp. and SilverCrest Mines Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Maria Smirnova: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None My company has a financial relationship with the following companies mentioned in this interview: Certain Sprott funds own shares of all five companies. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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