The
major silver miners’ stocks have been thrashed, pummeled to brutal
multi-year lows. They suffered serious collateral damage as silver
plunged on gold’s breakdown, driven by crazy-extreme all-time-record
silver-futures short selling. All this technical carnage left
investors reeling, devastating sentiment. The silver miners’
recently-reported Q2’18 results reveal whether their anomalous
plunge was justified fundamentally.
Four
times a year publicly-traded companies release treasure troves of
valuable information in the form of quarterly reports. Companies
trading in the States are required to file 10-Qs with the US
Securities and Exchange Commission by 45 calendar days after
quarter-ends. Canadian companies have similar requirements. In
other countries with half-year reporting, many companies still
partially report quarterly.
Unfortunately the universe of major silver miners to analyze and
invest in is pretty small. Silver mining is a tough business both
geologically and economically. Primary silver deposits, those with
enough silver to generate over half their revenues when mined, are
quite rare. Most of the world’s silver ore formed alongside base
metals or gold. Their value usually well outweighs silver’s,
relegating it to byproduct status.
The
Silver Institute has long been the authority on world silver
supply-and-demand trends. It published its latest annual World
Silver Survey covering 2017 in mid-April. Last year only 28%
of the silver mined around the globe came from primary silver
mines! 36% came from primary lead/zinc mines, 23% copper, and 12%
gold. That’s nothing new, the silver miners have long supplied less
than a third of world mined supply.
It’s
very challenging to find and develop the scarce silver-heavy
deposits supporting primary silver mines. And it’s even harder
forging them into primary-silver-mining businesses. Since silver
isn’t very valuable, most silver miners need multiple mines in order
to generate sufficient cash flows. Traditional major silver miners
are increasingly diversifying into gold production at silver’s
expense, chasing its superior economics.
So
there aren’t many major silver miners left out there, and their
purity is shrinking. The definitive list of these companies to
analyze comes from the most-popular silver-stock investment vehicle,
the SIL Global X Silver Miners ETF. In mid-August at the end of
Q2’s earnings season, SIL’s net assets were running 6.7x greater
than its next-largest competitor’s. So SIL continues to dominate
this small niche contrarian sector.
While SIL has its flaws, it’s the closest thing we have to a
silver-stock index. As ETF investing continues to eclipse
individual-stock picking, SIL inclusion is very important for silver
miners. It grants them better access to the vast pools of
stock-market capital. Differential SIL-share buying by investors
requires this ETF’s managers to buy more shares in its underlying
component companies, bidding their stock prices higher.
In
mid-August as the silver miners were finishing reporting their Q2’18
results, SIL included 23 “Silver Miners”. Unfortunately the great
majority aren’t primary silver miners, most generate well under
half their revenues from silver. That’s not necessarily an
indictment against SIL’s stock picking, but a reflection of the
state of this industry. There aren’t enough significant primary
silver miners left to fully flesh out an ETF.
This
disappointing reality makes SIL somewhat problematic. The only
reason investors would buy SIL is they want silver-stock exposure.
But if SIL’s underlying component companies generate just over a
third of their sales from silver mining, they aren’t going to be
very responsive to silver price moves. And most of that ETF capital
intended to go into primary silver miners is instead diverted into
byproduct silver miners.
So
silver-mining ETFs sucking in capital investors thought they were
allocating to real primary silver miners effectively starves them.
Their stock prices aren’t bid high enough to attract in more
investors, so they can’t issue sufficient new shares to finance big
silver-mining expansions. This is exacerbating the
silver-as-a-byproduct trend. Only sustained much-higher silver
prices for years to come could reverse this.
Every quarter I dig into the latest results from the major silver
miners of SIL to get a better understanding of how they and this
industry are faring fundamentally. I feed a bunch of data into a
big spreadsheet, some of which made it into the table below. It
includes key data for the top 17 SIL component companies, an
arbitrary number that fits in this table. That’s a commanding
sample at 95.8% of SIL’s total weighting!
While most of these top 17 SIL components had reported on Q2’18 by
mid-August, not all had. Some of these major silver miners trade in
the UK or Mexico, where financial results are only required in
half-year increments. If a field is left blank in this table, it
means that data wasn’t available by the end of Q2’s earnings
season. Some of SIL’s components also report in gold-centric terms,
excluding silver-specific data.
The
first couple columns of this table show each SIL component’s symbol
and weighting within this ETF as of mid-August. While most of these
stocks trade on US exchanges, some symbols are listings from
companies’ primary foreign stock exchanges. That’s followed by each
miner’s Q2’18 silver production in ounces, along with its absolute
year-over-year change. Next comes this same quarter’s gold
production.
Nearly all the major silver miners in SIL also produce
significant-to-large amounts of gold! That’s truly a double-edged
sword. While gold really stabilizes and boosts silver miners’ cash
flows, it also retards their stocks’ sensitivity to silver itself.
So the next column reveals how pure these elite silver miners
are, approximating their percentages of Q2’18 revenues actually
derived from silver. This is calculated two ways.
The
large majority of these top SIL silver miners reported total Q2
revenues. Quarterly silver production multiplied by silver’s
average price in Q2 can be divided by these sales to yield an
accurate relative-purity gauge. When Q2 sales weren’t reported, I
estimated them by adding silver sales to gold sales based on their
production and average quarterly prices. But that’s less optimal,
as it ignores any base-metals byproducts.
Next
comes the major silver miners’ most-important fundamental data for
investors, cash costs and all-in sustaining costs per ounce mined.
The latter directly drives profitability which ultimately determines
stock prices. These key costs are also followed by YoY changes.
Last but not least the annual changes are shown in operating cash
flows generated and hard GAAP earnings, with a couple exceptions
necessary.
Percentage changes aren’t relevant or meaningful if data shifted
from positive to negative or vice versa, or if derived from two
negative numbers. So in those cases I included raw underlying data
rather than weird or misleading percentage changes. This whole
dataset together offers a fantastic high-level read on how the major
silver miners are faring fundamentally as an industry. Was their
recent plunge righteous?
Production is naturally the lifeblood of the silver-mining sector.
The more silver and increasingly gold that these elite miners can
wrest from the bowels of the earth, the stronger their fundamental
positions and outlooks. These top 17 SIL silver miners failed to
increase their mining tempos over this past year. Their
collective silver and gold production deteriorated 4.4% and 2.1% YoY
to 75.1m and 1327k ounces mined.
According to the Silver Institute’s latest WSS, total world silver
mine production averaged 213.0m ounces per quarter in 2017. So at
75.1m in Q2, these top 17 SIL components were responsible for 35.3%
of that rate. And their overall production decline last quarter is
misleading, heavily skewed by two outliers with unusual situations.
Tahoe Resources and SSR Mining reported huge 100.0% and 46.3% YoY
production plunges!
Without TAHO and SSRM, the rest of these elite silver miners were
able to grow their collective silver production by a decent 2.0%
YoY. That’s impressive considering the miserable silver-price
environment. Between Q2’17 and Q2’18, the average quarterly silver
price slumped 3.9% to $16.51. That was really weak compared to
gold, which actually rose 3.9% in quarterly-average terms to $1306
across these quarters.
Silver has always been
driven by gold,
effectively acting like a gold sentiment gauge. Generally
big silver uplegs only happen after gold has rallied long enough and
high enough to convince traders its gains are sustainable. Then the
way-smaller silver market tends to start leveraging and amplifying
gold’s moves by 2x to 3x. But gold sentiment was so insipid over
this past year that no excitement was sparked for silver.
Yet
the top 17 SIL silver miners excluding TAHO and SSRM were able to
buck those silver headwinds to still grow production. That is
setting up these companies for stronger profits growth once silver’s
price inevitably mean reverts higher. It’s important to understand
what’s going on with TAHO and SSRM though, as these are long-time
favorites among American investors. TAHO’s silver production should
return.
Tahoe was originally spun off by Goldcorp to develop the incredible
high-grade Escobal silver mine in Guatemala, which went live in
Q4’13. Everything went well for its first few years. By Q1’17,
Escobal was a well-oiled machine producing 5700k ounces of silver.
That provided 1000+ great high-paying jobs to locals and contributed
big taxes to Guatemala’s economy. Escobal was a great economic boon
for this country.
But
a radical group of anti-mining activists managed to spoil
everything, cruelly casting their fellow countrymen out of work.
They filed a frivolous and baseless lawsuit against Guatemala’s
Ministry of Energy and Mines, Tahoe wasn’t even the target! It
alleged this regulator had not sufficiently consulted with the
indigenous Xinca people before granting Escobal’s permits. And they
don’t even live around this mine site.
Only
in a third-world country plagued with rampant government corruption
would a regulator apparently not holding enough meetings be a
company’s problem. Instead of resolving this, a high Guatemalan
court inexplicably actually suspended Escobal’s mining
license in early Q3’17! Tahoe was forced to temporarily mothball
its crown-jewel silver mine, and thus eventually lay off its
Guatemalan employees.
That
license was technically reinstated a couple months later, but the
activists appealed to a higher court. It required the regulator to
study the indigenous people in surrounding areas and report back,
and now needs to make a decision. The government also needs to
clear out an illegal roadblock to the mine site by violent anti-mine
militants, who have blockaded Escobal supplies and physically
attacked trucks and drivers!
So
Escobal has been dead in the water with zero production for
an entire year, an unthinkable outcome. This whole thing is a
farce, a gross miscarriage of justice. Sooner or later the
Guatemalan bureaucrats will get all their useless paperwork done and
Escobal will come back online. After a few quarters or so of
spinning back up, Escobal’s silver production should return to
pre-fiasco levels around 5700k ounces a quarter.
That
would boost SIL’s top 17 components’ current overall silver
production by 7.6%. In my decades of intensely researching and
actively trading mining stocks, I’ve never seen anything like this
Escobal debacle. While TAHO’s cashflows are really impaired without
this silver mine which was actually the world’s largest primary,
it can weather this nightmare because of its other gold mines that
yielded 102.6k ounces in Q2’18.
Thankfully SSR Mining’s silver-production plunge is far less
dramatic. This company used to be known as Silver Standard
Resources, and its old Pirquitas silver mine is simply depleting
as forecast. SSRM is exploring in the area trying to extend the
life of this old mine, which was joint-ventured and renamed the Puna
Operations. But most of SSRM’s resources are being poured into its
far-more-profitable gold mines.
That
gold focus among these top silver miners is common across SIL’s
components. As the silver-percentage column above shows, most of
these elite silver miners are actually primary gold miners by
revenue! Only 3 of these 17 earned more than half of their Q2’18
sales from mining silver, and they are highlighted in blue. WPM,
PAAS, and TAHO are also top-34 components in the leading
GDX gold miners’
ETF!
While they only comprised 7.8% of GDX’s total weighting in
mid-August, this highlights how difficult it is to find primary
silver miners. SIL’s managers have an impossible job these days
with the major silver miners increasingly shifting to gold. They
are really scraping the bottom of the barrel to find more silver
miners. In Q3’17 they added Korea Zinc, and it’s now SIL’s
3rd-biggest holding with a hefty 11.9% total weighting.
That
was intriguing, as I’d never heard of this company after decades
deeply immersed in this small silver-mining sector. So I looked
into Korea Zinc and found it was merely a smelter, not even a
miner! Its English-language disclosures are atrocious, starting
with its homepage reading “We are Korea Zinc, the world’s one of the
best smelting company”. The latest production data I can find in
English is still 2015’s.
That
year Korea Zinc “produced” 63.3m ozs of silver, which averages to
15.8m quarterly. That is largely a byproduct from its main
businesses of smelting zinc, lead, copper, and gold. The fact SIL’s
managers included a company like this that doesn’t even mine
silver as a top SIL component shows how rare major silver miners
have become. The economics of silver mining at today’s prices are
way inferior to gold mining.
The
traditional major silver miners are painfully aware of this, and
have spent years actively diversifying into gold. In Q2’18,
the average percentage of revenues these top 17 SIL miners derived
from silver was only 36.3%. That’s right in line with the recent
trend, with the prior four quarters seeing 36.1%, 39.3%, 35.3%, and
36.4%. This relatively-low silver exposure is why SIL isn’t as
responsive to silver as investors expect.
Silver mining is every bit as capital-intensive as gold mining,
requiring similar large expenses for planning, permitting, and
constructing mines and mills. It needs similar heavy excavators and
haul trucks to dig and move the silver-bearing ore. Similar levels
of employees are necessary to run these mines. But silver generates
much lower cash flows due to its lower price. Consider
hypothetical mid-sized silver and gold mines.
They
might produce 10m and 300k ounces annually. At last quarter’s
average prices, these silver and gold mines would yield $165m and
$392m of yearly sales. Unfortunately it is far easier to pay the
bills mining gold these days. So primary silver miners are
increasingly becoming a dying breed, which is sad. The traditional
major silver miners are adapting by ramping their gold production
often at silver’s expense.
This
industry’s flagging silver purity and thus deteriorating
responsiveness to silver price trends will be hard to reverse.
Silver would need to far outperform gold, rocketing higher in one of
its gigantic uplegs while gold lags. And it would have to stay
relatively strong compared to gold for years after that to
entice big capital spending back into primary silver mines. While
possible, that seems like a stretch in today’s markets.
Unfortunately SIL’s mid-August composition was such that there
wasn’t a lot of Q2 cost data reported by its top component miners.
A half-dozen of these top SIL companies trade in the UK, South
Korea, Mexico, and Peru, where reporting only comes in half-year
increments. There are also primary gold miners that don’t report
silver costs, and a silver explorer with no production. So silver
cost data remains scarce.
Nevertheless it’s always useful to look at what we have.
Industrywide silver-mining costs are one of the most-critical
fundamental data points for silver-stock investors. As long as the
miners can produce silver for well under prevailing silver prices,
they remain fundamentally sound. Cost knowledge helps
traders weather this sector’s occasional fear-driven plunges without
succumbing to selling low like the rest of the herd.
There are two major ways to measure silver-mining costs, classic
cash costs per ounce and the superior all-in sustaining costs. Both
are useful metrics. Cash costs are the acid test of silver-miner
survivability in lower-silver-price environments, revealing the
worst-case silver levels necessary to keep the mines running.
All-in sustaining costs show where silver needs to trade to maintain
current mining tempos indefinitely.
Cash
costs naturally encompass all cash expenses necessary to
produce each ounce of silver, including all direct production costs,
mine-level administration, smelting, refining, transport,
regulatory, royalty, and tax expenses. In Q2’18, these top 17
SIL-component silver miners that reported cash costs averaged just
$3.95 per ounce! That plunged a whopping 37.6% YoY, making it look
like these miners are getting more efficient.
But
that’s misleading. Because of hefty byproduct credits from gold and
base metals, Hecla Mining and Fortuna Silver Mines both reported
negative cash costs in Q2. They are an accounting fiction, as
mining silver still costs a lot of money. But crediting byproduct
sales to silver can slash reported cash costs. In the comparable
quarter a year earlier, there were no negative cash costs at any of
SIL’s top 17 miners.
Those super-low cash costs offset SSR Mining’s crazy-high $14.73 per
ounce. That’s not normal either, the result of that winding down of
its lone silver mine. Excluding these extreme outliers, the
remaining handful of silver miners had average cash costs of $4.83
per ounce. As long as silver prices stay above those levels, the
silver miners can keep the lights on at their mines. Sub-$5 silver
is wildly inconceivable!
Way
more important than cash costs are the far-superior all-in
sustaining costs. They were introduced by the World Gold Council in
June 2013 to give investors a much-better understanding of what it
really costs to maintain silver mines as ongoing concerns. AISCs
include all direct cash costs, but then add on everything else that
is necessary to maintain and replenish operations at current
silver-production levels.
These additional expenses include exploration for new silver to mine
to replace depleting deposits, mine-development and construction
expenses, remediation, and mine reclamation. They also include the
corporate-level administration expenses necessary to oversee silver
mines. All-in sustaining costs are the most-important silver-mining
cost metric by far for investors, revealing silver miners’ true
operating profitability.
In
Q2’18 these top 17 SIL miners reporting AISCs averaged just $10.93
per ounce! That was down 6.3% YoY, and was way below silver’s
average price of $16.51 last quarter. Even if the two extreme
outliers are thrown out, SSRM’s abnormally-high mine-depletion
$17.66 AISC and SVM’s incredibly-low huge-byproduct-credit $0.41
AISC, the remaining average is similar at $11.56. Silver mining
remains very profitable!
Even
at worst in August’s plunge driven by speculators’ crazy-extreme
all-time-record silver-futures short selling, silver merely hit
$14.44 on close. That’s still way above this industry’s total
production costs any way you slice it. That implies even at peak
fear the elite top silver miners of SIL were still earning hefty 24%
profit margins! So there’s no doubt the recent frantic silver-stock
selling wasn’t fundamentally righteous.
SIL
getting hammered to deep 2.5-year lows in mid-August was the product
of irrational fear run amok, it had nothing to do with how the
silver miners are faring. At Q2’s average silver price and AISCs,
these miners were earning $5.58 per ounce. Most other industries
would die for such 34% margins. And those are going to explode
higher as silver inevitably mean reverts back up again, probably
violently given this setup.
Silver stocks plunged in August because silver did. That was driven
by truly-extreme silver-futures short selling by speculators. They
ramped their shorts to a wild new all-time record high of 114.5k
contracts in mid-August! All that short selling is guaranteed
proportional near-future buying, as excessive shorts must be
closed by buying offsetting long contracts. Short-covering rallies
are self-feeding, catapulting silver higher.
The
more speculators buy to cover, the faster silver surges. The faster
it surges, the more they have to buy to cover or face catastrophic
losses due to the
extreme leverage inherent in silver futures. It would take
73.0k contracts of buying to return spec shorts to their 52-week low
seen in mid-September 2017. That’s the equivalent of 364.9m ounces,
or nearly 43% of last year’s entire global mined supply! Talk about
big.
And
today’s silver prices are super-low relative to prevailing gold
levels, portending huge mean-reversion upside. The long-term
average
Silver/Gold Ratio runs around 56x, which means it takes 56
ounces of silver to equal the value of one ounce of gold. Silver is
greatly underperforming gold so far in 2018, with the SGR averaging
a stock-panic-like 80.2x thus far in August! So silver is overdue
to catch up with gold.
At a
56x SGR and $1200 gold, silver is easily heading near $21.50.
That’s 30% above its Q2 average. Assuming the major silver miners’
all-in sustaining costs hold, that implies profits per ounce soaring
89% higher! And the record silver-futures short covering necessary
after record silver-futures short selling is very likely to fuel a
massive mean-reversion overshoot, making the
silver-mining-profits upside much greater.
And
silver miners’ AISCs generally don’t change much regardless of
prevailing silver prices, since silver-mining costs are largely
fixed during mine planning and construction. The top 17 SIL miners’
AISCs in the past four quarters averaged $11.66, $9.73, $10.16, and
$10.92. So Q2’18’s $10.93 was right in line. Costs aren’t going to
rise much as silver recovers, and higher production may even push
them lower still.
While all-in sustaining costs are the single-most-important
fundamental measure that investors need to keep an eye on, other
metrics offer peripheral reads on the major silver miners’
fundamental health. The more important ones include cash flows
generated from operations, GAAP accounting profits, revenues, and
cash on hand. They were all decent to healthy in Q2’18 despite the
low silver prices and weak sentiment.
These SIL-top-17 silver miners’ collective revenues only fell 1.5%
YoY to $3114m. That reflects higher gold prices which offset the
lower silver ones. That drove operating-cash-flow generation of
$758m, which was 27.0% lower YoY. That’s not unreasonable given the
3.9% lower average silver prices from Q2’17 to Q2’18 and the 4.4%
lower silver production among these elite silver majors. Cash flows
remain fine.
These silver miners’ balance-sheet cash and short-term investments
still powered 18.0% higher YoY to $3637m. The bigger their cash
hoards, the easier the elite silver miners can weather these weak
silver prices. Big treasuries also give them more capital to expand
existing mines and buy or build new ones. A fundamental surprise
seemed to come in hard GAAP accounting profits though, which soared
110.6% YoY!
But
the $343m total earnings in Q2’18 were wildly skewed by a huge $246m
non-recurring gain Wheaton Precious Metals reported. 77% of its
massive $318m in profits came from gains on the sale of one of its
silver streams. Back that out of overall top-17-SIL-component
earnings, and they actually plunged 40.3% YoY. But they were still
positive at $97m, and have incredible upside potential as silver’s
price inevitably recovers.
The
silver-mining stocks are doing way better fundamentally than they’ve
been given credit for. Their mining costs remain far below
prevailing silver levels, driving strong profitability even at
August’s deep silver-price lows. That capitulation silver-stock
plummeting fueled by cascading selling as stop losses were
sequentially run wasn’t justified fundamentally. It was an extreme
sentiment anomaly that can’t persist.
So a
big mean-reversion rebound higher is inevitable and imminent. While
traders can play that in SIL, that’s mostly a bet on primary gold
miners with byproduct silver production. The best gains by far will
be won in smaller purer mid-tier and junior silver miners with
superior fundamentals. A carefully-handpicked portfolio of these
miners will generate much-greater wealth creation than ETFs
dominated by non-primary miners.
At Zeal we’ve
literally spent tens of thousands of hours researching
individual silver stocks and markets, so we can better decide what
to trade and when. As of the end of Q2, this has resulted in 1012
stock trades recommended in real-time to our newsletter subscribers
since 2001. Fighting the crowd to buy low and sell high is very
profitable, as all these trades averaged stellar annualized realized
gains of +19.3%!
The key to this
success is staying informed and being contrarian. That means
buying low when others are scared, before undervalued silver stocks
soar much higher. An easy way to keep abreast is through our
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and ongoing research to explain what’s going on in the markets, why,
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while great silver stocks remain dirt-cheap!
The
bottom line is the major silver miners’ fundamentals remain solid
based on their recently-reported Q2’18 results. They continue to
mine silver at all-in sustaining costs far below even mid-August’s
deep silver lows. Their still-impressive profits will multiply as
silver rebounds higher violently on record futures short covering.
Investment capital will flood back into this tiny sector,
catapulting silver stocks up sharply.
So
traders need to look through the recent frightened herd sentiment to
understand the silver miners’ hard fundamentals. These forsaken
stocks are radically undervalued even at today’s low silver prices,
let alone where silver heads during the next major gold upleg.
Silver is poised to rocket higher soon as that mandatory extreme
short covering gets underway. So the opportunities to buy
dirt-cheap miners are fleeting. | 
