Silver miners’ Q1’18 fundamentals

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-May at the end of Q1’s earnings season, SIL’s net assets were running 6.4x 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-May as the major silver miners were finishing reporting their Q1’18 results, SIL included 24 “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 well under 40% of their sales from silver mining, they aren’t going to be very responsive to silver price moves.  And most of that capital intended to go into primary silver miners is instead diverted into byproduct silver miners.

So the 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 tragedy.

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 95.1% of SIL’s total weighting!

While most of these top 17 SIL components had reported on Q1’18 by mid-May, 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 Q1’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-May.  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 Q1’18 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 Q1’18 revenues actually derived from silver.  This is calculated two ways.

The large majority of these top SIL silver miners reported total Q1 sales.  Those are divided by quarterly silver production multiplied by silver’s average price in Q1, yielding an accurate relative-purity gauge.  In cases where Q1 sales weren’t reported, I estimated them by adding silver sales to gold sales based on their production and average quarterly prices.  That’s less optimal, since it ignores any base-metals production.

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.  They kept hanging in there in Q1’18.

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 strangely gold’s strength over the past year didn’t spill into silver, leaving its miners struggling.

Silver’s average price actually fell 4.1% between Q1’17 and Q1’18, despite a sizable 8.9% YoY rally in gold’s average price!  Normally silver would’ve powered 18% to 27% higher on such a meaningful gold advance.  But it went the other way because gold sentiment remained poor.  Investors spent 2017 deeply enamored with the extraordinary levitating general stock markets, ignoring everything else including gold and silver.

With investors not interested, the already-battered silver stocks continued to languish near lows for most of 2017.  These miners had insufficient capital and incentives to grow production, which is the lifeblood of mining.  So unfortunately these top 17 SIL components collectively suffered sharp declines in both silver and gold production over the past year.  That naturally hurt their operating and financial results in Q1’18.

These elite major silver miners’ total silver mined last quarter fell 5.3% YoY to 72.0m ounces!  That was certainly not offset by higher gold production, which dropped an even-worse 8.1% YoY to 1243k ounces.  And sadly those production declines are actually skewed smaller than sector reality.  Note above the only big absolute gains in silver production came from two silver behemoths, Fresnillo and Industrias Peñoles.

Their silver production soared 14.0% and 13.1% YoY in Q1, bucking the weakening trend seen in many of the rest of these major miners.  Together Fresnillo and Peñoles added 3.9m ounces of silver mined to the SIL-top-17 total.  Without that huge boost, the overall silver production for these elite miners would’ve fallen a huge 10.4% YoY.  And I suspect these Mexican giants’ silver production may be double-counted.

Fresnillo and Industrias Peñoles have an incestuous relationship, as the former used to be wholly owned by the latter.  Industrias Peñoles spun off Fresnillo back in May 2008 on the London Stock Exchange.  While Fresnillo’s financial reporting is decent, Industrias Peñoles’ is murky.  Neither my decades studying financial statements as a Certified Public Accountant nor my rudimentary Spanish can penetrate very deep.

So I haven’t been able to track down how much of Fresnillo that Industrias Peñoles still owns, nor whether the silver production reported by these silver-mining monsters is actually fully mutually exclusive.  I’m assuming it is for this analysis, but I’m skeptical.  Both companies reported their huge YoY growth in silver production was the result of Fresnillo’s new San Julián silver mine ramping up, which is a big one.

San Julián produced 3568k ounces of silver in Q1’18 alone, along with fairly-large gold, zinc, and lead byproducts.  It’s anticipated to produce 11.6m and 63.7k ounces of silver and gold annually for 12 years.  Without San Julián, which could be double-reported between Fresnillo and Industrias Peñoles, the top SIL silver miners’ production would look very different.  These elite silver miners have had a challenging year.

Fully excluding Fresnillo and Peñoles, the rest of these top SIL components saw their collective silver production plunge 16.8% YoY to 39.2m ounces!  The mediocre silver-mining economics from these weak silver prices combined with company-specific problems have really hit this industry.  Leading the drop in silver production were a couple of long-time American favorites, Tahoe Resources and SSR Mining.

Tahoe was originally spun off by Goldcorp to develop the incredible high-grade Escobal silver mine in Guatemala.  Everything went well for its first few years, with this mine providing 1000+ great high-paying jobs to locals and contributing big taxes to the national economy.  Then a group of anti-mining activists filed a frivolous and baseless lawsuit with the intent of shutting down Escobal.  The whole thing was a farce.

Tahoe wasn’t even the target, Guatemala’s Ministry of Energy and Mines was.  This regulator allegedly did not sufficiently consult with the Xinca indigenous people before granting Escobal’s permits!  Only in a third-world country plagued with rampant government corruption would that be Tahoe’s problem instead of bureaucrats’.  They apparently didn’t hold enough meetings, so Escobal’s mining license was actually suspended.

Tahoe was forced to temporarily mothball its crown-jewel silver mine, and eventually fire many of its local Guatemalan employees.  The dishonorable Guatemalan government continues to drag its feet on this case, inexplicably strangling one of its largest taxpayers.  It has even allowed violent anti-mine militants to illegally blockade the road to Escobal, often physically attacking trucks and drivers supplying this mine!

Thus Tahoe’s silver production plummeted 100% YoY from 5700k ounces to zero!  That’s certainly not an existential threat, as Tahoe still has other sizable gold-mining operations.  In early May’s Q1’18 report, Tahoe’s management is still optimistic a court ruling in its favor is soon coming.  Then its licenses will be reinstated and it can slowly resume mining at Escobal.  Hopefully this whole mess isn’t a stealth expropriation.

SSR Mining’s silver production fell a less-extreme-but-still-huge 38.3% YoY to 938k ounces in Q1’18.  This has nothing to do with geopolitics like Tahoe’s nightmare, but is simply the forecast depletion of its old Pirquitas silver mine.  SSR Mining, which used to be called Silver Standard Resources, is exploring in the area trying to extend the life of this mine.  But most of its financial resources are being poured into its 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 Q1’18 sales from mining silver, and they are highlighted in blue.  WPM, HL, PAAS, CDE, and TAHO are also top-34 components in the leading GDX gold miners’ ETF!

While they only comprised 8.7% of GDX’s total weighting in mid-May, 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 of intensely studying and actively trading silver stocks.  So I looked into Korea Zinc and found it was merely a smelter, not even a miner!  The latest financial data I could find in English was 2015’s.  That year Korea Zinc “produced” 63.3m ounces of silver, which was largely a byproduct from its main business of smelting zinc, lead, copper, and gold.

I ran the numbers for the heck of it, and silver was implied as 32% of Korea Zinc’s 2015 revenues.  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 inferior to gold mining.  Thus the average silver-purity percentage of revenues of these SIL miners is only 36.8%.

That’s right in line with the past year’s trend, with 2017 seeing 38.5%, 37.6%, 40.1%, and 35.8% from Q1 to Q4.  This reflects gold mining’s economics being superior to silver mining’s these days.  Silver mining is 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.

But silver generates much lower cash flows due to its lower price.  Consider hypothetical mid-sized silver and gold miners, which might produce 10m and 300k ounces annually.  At last quarter’s average metals prices, these silver and gold mines would yield $167m and $399m of yearly sales.  It’s far easier to pay the bills mining gold than silver, which is unfortunate.  But until silver surges again, that’s the way things are.

While I understand this, as a long-time silver-stock investor it saddens me primary silver miners have apparently become a dying breed.  When silver starts powering higher in one of its gigantic uplegs and way outperforms gold again, this industry’s silver-purity percentage will rise.  But unless silver not only shoots far ahead but stays there while gold lags, it’s hard to see major-silver-mining purity significantly reversing.

Unfortunately SIL’s mid-May composition was such that there wasn’t a lot of Q1 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 Q1’18, these top 17 SIL-component silver miners that reported cash costs averaged $5.05 per ounce.  That plunged a whopping 25.2% YoY, making it look like silver miners are far 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 Q1.  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 $17.07 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 $5.50 per ounce.  As long as silver prices stay above those levels, the silver miners can keep the lights on at their mines.  Sub-$6 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 a silver mine as an ongoing concern.  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 Q1’18 these top 17 SIL miners reporting AISCs averaged just $10.92 per ounce.  That’s down 5.1% YoY, and still way below last quarter’s low average silver price of $16.72.  Excluding SSRM’s $18.37 which is again a non-representative mine-depletion outlier, that slides to $9.42.  Despite all the tough challenges the major silver miners are facing, they are still able to produce silver quite profitably today.

All-in sustaining costs and production are inversely related.  Lower silver production, which many of SIL’s top components suffered last quarter, leaves fewer ounces to spread the big fixed costs of mining across.  Yet average AISCs still retreated, showing these top silver miners are getting more efficient at producing their metal.  That will grant the silver miners more upside profits leverage to rising silver as this metal recovers.

With last quarter’s $16.72 average silver price, $10.92 AISCs show the silver miners still earning pretty-fat profits of $5.81 per ounce.  That’s actually only down 2.2% YoY because Q1’17’s higher silver prices were paired with higher AISCs.  Since mining costs are largely fixed during planning and construction, these silver-mining profits will explode as silver mean reverts higher.  And silver has vast room to run from here.

Today’s silver price remains crazy-low relative to prevailing gold levels, portending huge mean-reversion upside.  The long-term average Silver/Gold Ratio runs around 56, 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 79.6 YTD as of late May!  So silver is overdue to catch up with gold.

At a 56 SGR and $1300 gold, silver is easily heading near $23.25.  That’s 39% above its Q1 average.  Assuming the major silver miners’ all-in sustaining costs hold, that implies profits per ounce soaring 112% higher!  Plug in a higher gold price or the usual mean-reversion overshoot after an SGR extreme, and the silver-mining profits upside is far greater.  Silver miners’ inherent profits leverage to rising silver is incredible.

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 all deteriorated in Q1’18, as you’d expect with lower silver production and prices.

Before we get into them, these comparisons are a bit misleading.  In Q1’18 12 of these SIL-top-17 silver miners reported quarterly financial results, compared to 14 a year earlier.  So it’s not quite an apples-to-apples comparison.  One reason is Silvercorp Metals, which clawed its way back into SIL’s top 17 over the past year.  SVM tends to meander in and out of that 17th spot depending on its market cap relative to its peers.

SVM has a fiscal year ending March 31st, so its full-year results that require more time to prepare and get audited come later than normal quarterly results.  I did all the underlying data collection and analysis for this essay, and wrote the draft, before they were reported in late May.  Korea Zinc also doesn’t report in English as far as I can tell.  Both of these light-blue-highlighted stocks weren’t in SIL’s top 17 a year ago.

Among these top SIL components reporting Q1’18 financial results, operating cash flows plunged 33.6% YoY to $528m.  That’s still a strong number for such a small industry, proving that silver mines are still heavily cash-flow positive in general.  Since cash on balance sheets actually slid 4.6% YoY to $2973m, the silver miners were apparently spending that cash flow on expansions that have yet to bear production fruit.

Overall sales among these elite silver miners dropped 13.0% YoY to $2699m.  That makes sense given their 5.3% lower silver production and 4.1% lower average silver prices in Q1.  Of course profits amplify falling sales, so the top 17 SIL silver stocks saw earnings plunge 24.1% YoY to $273m.  But these silver miners were still enjoying profitable operations even with silver mired near lows in such miserable bearishness.

As silver powers higher in coming quarters, silver-mining profits will really leverage its advance.  And that will fundamentally support far-higher silver-stock prices.  The investors who will make out like bandits on this are the early contrarians willing to buy in low, before everyone else realizes what is coming.  By the time silver surges higher with gold so silver stocks regain favor again, the big gains will have already been won.

While investors and speculators alike can certainly play the silver miners’ long-stalled mean-reversion bull with this leading SIL ETF, individual silver stocks with superior fundamentals will enjoy the best gains by far.  Their upside will trounce the ETFs, which are burdened by companies that don’t generate enough of their sales from silver.  A handpicked portfolio of purer elite silver miners will yield much-greater wealth creation.

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 Q4, this has resulted in 983 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 +20.2%!

The key to this success is staying informed and being contrarian.  That means buying low before others figure it out, before undervalued silver stocks soar much higher.  An easy way to keep abreast is through our acclaimed weekly and monthly newsletters.  They draw on my vast experience, knowledge, wisdom, and ongoing research to explain what’s going on in the markets, why, and how to trade them with specific stocks.  For only $12 per issue, you can learn to think, trade, and thrive like contrarians.  Subscribe today, and get deployed in the great gold and silver stocks in our full trading books!

The bottom line is the major silver miners fared fine in Q1 despite some real challenges.  A combination of silver continuing to seriously lag gold, along with anomalous company-specific problems, weighed on miners’ collective results.  Yet they continued to produce silver at all-in sustaining costs way below Q1’s low prevailing silver prices.  And their ongoing diversification into gold leaves them financially stronger.

With silver-stock sentiment remaining excessively bearish, this sector is primed to soar as silver itself resumes mean reverting higher to catch up with gold’s young bull market.  The silver miners’ profits leverage to rising silver prices remains outstanding.  After fleeing silver stocks so relentlessly over the past 21 months, investors will have to do big buying to reestablish silver-mining positions.  That will fuel major upside.

Adam Hamilton, CPA

June 1, 2018

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