Silver is correcting again after a run to last
year’s high at $8.30. There seems to be a general consensus among
silver gurus and commentators alike (David Morgan, Doug Casey, Jim Dines and
others) that silver price has broken out of its 20 year downturn. Since
silver equities typically outperform the metal, investor interest is slowly
being drawn to silver mining stocks, which for variety of reasons aside from
the rising price of the metal, present a unique investment opportunity. We
are at the dawn of a new era for silver (and other “things” vs. “paper”).
Perception Is King
Silver is both precious and industrial metal. Therefore
it is a potential beneficiary of ascending prices we are witnessing in
industrial and base metals as well as precious metals. Another unique
characteristic of investing in silver stocks is that there are few choices
available amongst publicly-traded companies, and even fewer that are primary
silver plays. One could make the argument that buying a basket of silver
equities will provide leverage to silver and portfolio diversification. Yet
the universe of public silver companies is so small that buying 20 or so
stocks covers the entire sector. Even adding silver miners with significant
exposure to other metals that often accompany silver in the ground, such as
gold, copper, lead and zinc, we still come up with a very short list of
silver stocks. Best proof of this thesis is the companies with assets
primarily in lead, zinc, copper and even gold, which are presenting
themselves as leveraged plays on silver.
On the other hand it has become apparent that for
short term investing the merits of company’s assets are irrelevant. It
is the perception that matters in the short term, not the fundamentals. That
said, expect that over the short to medium term all
sorts of companies will do well – “even turkeys fly in a
hurricane”. Some do, because they are real companies with solid
fundamentals, and others, whose main asset is an aggressive marketing policy
or a smartly picked name. This leaves a lot of room for “market
dislocations” where some sound investment opportunities are overlooked.
To date the average precious metal investor has been
a slave to the same emotional approach and desire to “make a
killing” that are present in any market, amply encouraged and exploited
by pseudo experts. So much for hard-money supporters whom today’s gold
and silver investors deem themselves to be. In that respect current precious
metal investment sentiment is hardly different from that of nanotech or even
real estate sector.
In the last two years in US and Canada only there has been $11
billion (with a “B”) raised in financings by mining and
exploration companies. I would speculate that if only 3% of that money was
used to buy silver bullion, silver price would be above $10 today. Instead we
have a year-long correction in mining stocks. So all those investors choosing
paper only and no bullion are shooting themselves in the foot. Don’t
get me wrong, I own silver stocks. But I do own bullion and continue to buy
it regularly – something all investors should be doing.
What is your measuring stick?
Interesting phenomenon about silver and, perhaps,
mining stocks in general, is the various benchmarks investors develop in
order to try and value these stocks, which present unique challenges in
valuation as opposed to say banking stocks. Here is an instance where an
ethical and experienced mining analyst, newsletter writer or website editor
can be of immense value. Presumably, they engage in much more research than
the average investor is able to do. But again, caution is in order: mining is
an inherently risky and speculative business. On the surface high-risk
carries a promise of high reward but there is more to it. To demonstrate the
point I will use this rhetoric between Doug Casey and Rick Rule in relation
to the matter at hand. The story was conveyed to yours truly by Rick Rule at
one of the investment conferences so I apologize for any incorrect details. Yet
I think I got the gist of it right.
Back in the day before the internet, when resource
investing was as challenging as ever Doug Casey wrote a piece on investing in
junior resource stocks. Doug made a point that because investing in these
stocks was so risky and the success rate so miniscule one would be well
advised to buy a basket of 30 of stocks to participate in the sector. Such an
approach, Casey explained, would provide for better risk management and
increase the chances for success. Upon reading that Rick Rule responded. Rick
reasoned that if it was known going in that success rate among these stocks
was so truly dismal, which it was, perhaps a better strategy would be to
short those same 30 stocks!
Obviously neither one of these two gentlemen needs
introduction. There are few if any resources investors who can rival their
respective track records in the last three decades. In the story above, both
make compelling arguments, yet the solutions they offer oppose one another. Indeed,
there is but one path to profits.
Investors should look at all the different methods
of valuing these stocks and make their investment decision based on an
all-around approach. But here’s the tricky part. Wonder why there are
so few commentators on silver? Simply put, there are so few silver stocks,
and even fewer that will ever produce silver, that precious metal analysts
will almost always gravitate to gold. Plus, generally speaking, gold is more
economic to mine than silver. FOR NOW it is.
Leverage to Silver
Leverage to silver is one factor that silver
investors often refer to as motivation to buy silver stocks. The question is
- how does one measure such leverage, particularly for companies with
resource or reserve studies?
One method widely used today is silver ounces per
share of stock. However, questions arise about the quality of their
resources: What are projected production costs? What will it take to put
their properties in production? All ounces are not created equal. The
definition of resources is an estimate of silver in the ground for which
advanced study has not been completed proving the (profitable) economics of
mining that silver.
But wait you say, we all know how expensive it is to
build a mine and infrastructure. If so shouldn’t companies that are
producing silver or nearing production carry a premium?
I would think so. Thus we enter the realm of the few companies that are
primary producers: Coeur d’Alene Mines, Hecla Mining Company, Pan
American Silver, First Silver Reserve and recently Genco
Resources, Endeavor Silver, Sterling Mining and
First Majestic have begun producing, though much smaller amounts of silver
currently. The list can be expanded to consider companies that appear to have
a rapidly growing production potential: Apex Silver, Excellon
Resources, Scorpio Mining, Macmin Silver and Silvercorp Metals (formerly SKN Resources) come to mind.
Since silver is often mined along with gold, lead,
zinc, copper and sometimes other minerals there are no “pure”
silver companies, (with the exception of Silver Wheaton which a royalty
company). Perhaps the next step is to find out what percentage of each
company’s assets is represented by silver. This is a tough one because
few of these companies are primarily silver companies.
In fact if one measures by a percentage of silver to
total mineral resources, only a handful of principally known silver companies
have 90% of their assets in silver – Silver Wheaton, IMA Exploration,
Sterling Mining, Pan American Silver, Silver Standard and Coeur D’Alene
Mines.
Leverage to Silver Versus Other Metals
Here the discussion becomes interesting, because
there are several companies whose overall metal content in other metals is
close to or higher than silver content. Plus with metal prices rising across
the board some of them offer significant leverage to both silver and other
metals. Companies in this category include Mines Management (fantastic
exposure to copper), Minefinders (gold exposure),
Canadian Zinc (zinc), Apex Silver (zinc/lead exposure), Gammon Lake
(gold), Western Silver (copper/lead/zinc), Genco
Resources (copper), Kimber
Resources (gold) and so on. Even Hecla Mining should be included in this
group as more than half of its revenue comes from gold. There is nothing wrong
with these companies and a lot of things are right. Some of them are
extremely well run. And the sole fact that they stress their exposure to
silver should tell you volumes about the potential they see in silver.
One advantage these companies have over
“pure” silver plays, at least in theory, is the fact that their
stock price is less dependent on wild fluctuations of silver price and
therefore offers less heartache and more stability to investors.
Name Recognition
It’s almost fashionable to be a silver company
these days (a little less than uranium or moly, but
still). As silver prices rise you will see more and more companies portraying
themselves as “silver companies or projects“. You will see old
ventures dug up and re-packaged. You will be dazzled by the geological terms
and maps and the invariable pictures of helicopters. Curiously, I could never
figure out why having to use a helicopter to get to one’s property was
considered a positive by mining companies and widely used in marketing
materials. Even more puzzling is the fact that investors must like it if
companies continue to use such pictures for decades. But I digress.
For the shorter term investors, name recognition can
dictate the market price, as well as recommendations by newsletter writers and
website writers, more so than the intrinsic value. This is an important
point: why bother with merits of the investment when all you need to do is
understand what motivates others to buy the stock. Newsletter writers,
website writers will not appreciate this way of valuing a stock, but frankly
it is almost as valid as any other, at least in the short run.
However, the operating strategy of the company
should be combined with marketing and capitalization strategy at once, and
some companies do a great job of establishing and maintaining their names as
well recognized silver plays. Hecla Mining and Coeur d’Alene Mines as NYSE companies
come to mind. Silver Standard has done a superb job for itself and the
industry, with a consistent marketing message on the merits of buying the few
silver stocks out there as un-expiring call option on silver. Pan American
Silver is obviously a name most investors recognize. Those investors who only
trust hard-cold bullion in their hands will now have a chance to get it from
Pan American, as the company announced minting its own bullion products last
week. This move should further bolster the image of Pan American as the
premier silver company.
Management
Perhaps this is the least tangible but most
important factor in valuing a company, and this is where knowledgeable
commentators with experience in the sector and industry can truly help you
make informed decisions. Unfortunately, any analysis of the management is
highly subjective and there is no way around it. Personally, I found it very
helpful to go to mining shows and meet the management of the companies of
interest. There is no substitute to face to face conversation. The next best
thing is calling the company on the phone. Unlike most other types of
businesses, most mining companies will gladly talk to you. Regular
communication can help you stay on top of your investments, especially if you
know the right questions to ask.
Can They Make a Profit?
This may come as a surprise to you, but there
aren’t any companies making money by producing silver. Not on an annual
basis anyway, sure a few have shown quarterly earnings, but no primary silver
producer has shown a profit on an annual basis yet, even with higher silver
prices.
One would think that a mining company cannot keep issuing
new shares forever and eventually will have to show some earnings. Those
companies that have a chance to be profitable from silver production at
current prices represent a small group indeed. While they may not have the
upside potential of early stage exploration plays, on a risk-adjusted basis
they are better plays for the longer-term investors. Keep in mind it is very
difficult for a producing company to stick with silver alone in the long run.
Due to the paucity of primary silver mines, companies almost invariably add
non-silver assets. There are exceptions like Pan American Silver.
Investors should be aware of this and choose
equities based on their investment goals and risk tolerance. Of course, the
good news is that when the silver price goes up, way up, most silver
producers are likely to become top dividend payers and turn into
“conservative investments”. At least that is how things played
out in the last bull market.
Blue Sky Exploration Potential
This is the category where junior stocks can excel,
but one of the hardest to evaluate for those outside the industry. Even
experienced newsletter writers often do not have the time to thoroughly
investigate each company. But the potential for very high investment returns,
although with high risk, is so appealing that eventually it grabs almost
every precious metals investor by the collar.
Every company claims upside potential, how does the
average investor see the real deal, and even if it is a real deal as they
say, the business is so risky, no one can guarantee exploration success. Assuming
that bonanza is in the ground, can the management translate that into profits
in your account?
Several juniors are focusing primarily on silver
exploration these days. But that number is nothing compared to gold and base
metal explorers. Some companies become “silver stories” by virtue
of their projects even if they were looking for other minerals to begin with.
Of course, when a junior company makes a discovery the up side potential is
only limited by the size of the project.
Investment philosophy
Investors develop their own investment philosophy. Most
in the precious metals sector become quite proud of their philosophy and woe
to anyone who tells them different! Any stock broker will tell you that the
biggest obstacle to consistent investment returns is the clients’
investment philosophy.
The silver story so compelling, that I believe, long
term investor in silver and silver stocks will see truly spectacular returns.
Silver represents a unique investment opportunity that is supported by the
economic trends both for the metal itself and the world economy. Silver
equities represent the best way to play the future price increases in silver,
and because of the small universe of silver stocks, one can build a diverse
portfolio to cover most if the whole silver sector.
Lastly, don’t forget that the day when your
silver investments will start paying off for the time being depends on YOUR
BUYING OF PHYSICAL SILVER. Pan American figured out. Hopefully other movers
and shakers of the sector as well as investors, large and small, figure it
out soon enough. It’s that simple: you buy silver and your silver
stocks will go up.
By : Sean
Rakhimov
Editor, www.silverstrategies.com/
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