Silver miners’ Q3’17 fundamentals

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, and their value usually well outweighs silver’s. So typically in any given year, less than a third of the global mined silver supply actually comes from primary silver mines!

The world authority on silver supply-and-demand fundamentals is the Silver Institute. Back in mid-May it released its latest annual World Silver Survey, which covered 2016. Last year only 30% of silver mined came from primary silver mines, a slight increase. The remaining 70% of silver produced was simply a byproduct. 35% of the total mined supply came from lead/zinc mines, 23% from copper, and 12% from gold.

As scarce as silver-heavy deposits supporting primary silver mines are, primary silver miners are even rarer. Since silver is so much less valuable than gold, most silver miners need multiple mines in order to generate sufficient cash flows. These often include non-primary-silver ones, usually gold. More and more traditional elite silver miners are aggressively bolstering their gold production, often at silver’s expense.

So the universe of major silver miners is pretty small, 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. This week its net assets are running 6.6x greater than its next-largest competitor’s, so SIL really dominates this space. With ETF investing now the norm, SIL is a boon for its component miners.

While there aren’t many silver miners to pick from, major-ETF inclusion shows silver stocks have been vetted by elite analysts. Due to fund flows into top sector ETFs, being included in SIL is one of the important considerations for picking great silver stocks. When the vast pools of fund capital seek silver-stock exposure, their SIL inflows force it to buy shares in its underlying companies bidding their prices higher.

Back in mid-November as the major silver miners finished reporting their Q3’17 results, SIL included 29 “silver miners”. This term is used loosely, as SIL holds plenty of companies which can’t be described as primary silver miners. Most generate well under half their revenues from silver, which greatly limits their stock prices’ leverage to silver rallies. Nevertheless, SIL is today’s leading silver-stock ETF and benchmark.

The higher the percentage of sales any miner derives from silver, naturally the greater its exposure to silver-price moves. If a company only earns 20%, 30%, or even 40% of its revenues from silver, it’s not a primary silver miner and its stock price won’t be very responsive to silver itself. But as silver miners are increasingly actively diversifying into gold, there aren’t enough big primary silver miners left to build an ETF alone.

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 92.7% of SIL’s total weighting.

While most of these top 17 SIL components had reported on Q3’17 by midNovember, 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 Q3’s earnings season. Some of SIL’s components also report in gold-centric terms, excluding silver-specific data.

In this table the first couple columns show each SIL component’s symbol and weighting within this ETF as of mid-November. While most of these silver stocks trade in the States, not all of them do. So if you can’t find one of these symbols, it’s a listing from a company’s primary foreign stock exchange. That’s followed by each company’s Q3’17 silver production in ounces, along with its absolute year-over-year change.

After that comes this same quarter’s gold production. Pretty much every major silver miner in SIL also produces significant-if-not-large amounts of gold! While gold stabilizes and augments the silver miners’ cash flows, it also retards their stocks’ sensitivity to silver itself. Naturally investors and speculators buy silver stocks and their ETFs because they want leveraged upside exposure to silver’s price, not gold’s.

So the next column reveals how pure the elite SIL silver miners are. This is mostly calculated by taking a company’s Q3 silver production, multiplying it by Q3’s average silver price, and then dividing that by the company’s total quarterly sales. If miners didn’t report Q3 revenues, I approximated them by adding the silver sales to gold sales based on their quarterly production and these metals’ average third-quarter prices.

Then comes the most-important fundamental data for silver miners, cash costs and all-in sustaining costs per ounce mined. The latter determines their profitability and hence ultimately stock prices. Those are also followed by YoY changes. Finally comes the YoY changes in cash flows generated from operations and GAAP profits. But an exception is necessary for companies with numbers that crossed zero since Q3’16.

Percentage changes aren’t relevant or meaningful if data shifted from negative to positive or vice versa. Plenty of major silver miners suffered net losses in Q3’17 after earning profits in Q3’16. So in cases where data crossed that zero line, I included the raw numbers instead. This whole dataset offers a fantastic highlevel fundamental read on how the major silver miners are faring today, and it’s reasonably well.

That’s reassuring given silver’s serious underperformance relative to gold this year. As a far-smaller market, silver usually amplifies gold’s advances by at least 2x. But as of the end of Q3, silver was only up 4.6% YTD compared to 11.3% for gold. That’s horrendous 0.4x leverage! And by mid-November as Q3’s earnings season wrapped up, silver’s YTD gain of 6.6% was still way behind gold’s 11.1% for 0.6x leverage.

Production is the lifeblood of miners, and thus the best place to start fundamental analysis. In Q3’17, these top 17 SIL components collectively produced an impressive 79.0m ounces of silver. If 2016’s world-silver-mining run rate is applied to this year’s third quarter, that implies 221.5m ounces of silver mined. Thus these top SIL silver miners would account for nearly 36% of that total, they truly are major silver players.

Their collective silver production looks robust, surging 3.7% YoY and climbing 0.6% sequentially quarter-on-quarter. Unfortunately that is misleading, with huge growth in a couple mining conglomerates masking sharp-to-catastrophic YoY declines for most of the rest of these elite silver miners. Fresnillo and Industrias Peñoles enjoyed gigantic 24% and 34% YoY gains in silver production off already-massive bases!

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 behemoths is actually 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 coming online, which is a big one.

San Julián produced 3499k ounces of silver in Q3’17 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.

Excluding Fresnillo and Industrias Peñoles, the rest of these top SIL components saw their collective silver production fall a sharp 9.3% YoY to 45.9m ounces! It’s been quite ugly out there in silver-land, for both industry-wide and company specific reasons. Between Q3’16 and Q3’17, the average silver price dropped 13.9% YoY to just $16.84. That was far worse than gold’s 4.2% YoY decline, testing silver’s economics.

With silver prices so weak, sentiment so bearish, and silver-stock prices so darned low, silver miners are both starved of capital for expansions and reluctant to invest heavily in the silver side of their businesses. Mining gold is far more profitable at today’s precious metals’ prices, so they continue to allocate scarce resources to growing their gold production. That certainly isn’t helping the purity of the major silver miners. A couple long-time favorites of American investors saw silver production plummet over this past year. Tahoe Resources was originally spun off by Goldcorp to develop the incredible high-grade Escobal silver mine in Guatemala. Over the past year that country’s corrupt government shut this mine down after a frivolous and baseless lawsuit by anti-mining activists. They sued the government regulator, not Tahoe itself!

That lawsuit claimed Guatemala’s Ministry of Energy and Mines did not properly consult with the Xinca indigenous people before granting Escobal’s permits! That shouldn’t even be Tahoe’s problem if the government bureaucrats didn’t hold enough meetings, yet Escobal’s mining license was still temporarily suspended. It has since been reinstated, but the government is not breaking up an illegal roadblock to the mine.

This whole situation is ludicrous, highlighting why third-world countries stay that way. The government of Guatemala isn’t respecting the rule of law, which will greatly hurt future investment. It’s allowing violent anti-mine militants to physically attack trucks and their drivers heading to Escobal. They should be arrested and the blockade cleared. Thus Tahoe’s silver production collapsed 100% YoY from 5000k ozs in Q3’16!

SSR Mining saw a similar sharp 62% YoY plummet in silver production to just 1156k ounces in Q3’17. It had nothing to do with geopolitics like Tahoe’s mess, but is simply due to 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 component companies. As the silver-percentage column above shows, most of these elite silver miners are actually primary gold miners by revenue! Only 6 of these 17 earned more than half of their Q3’17 sales from mining silver, and they are highlighted in blue. 8 of SIL’s top 17 component stocks are also included in the leading GDX gold miners’ ETF.

While they only comprised 10.0% of GDX’s total weighting in mid-November, 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, making it SIL’s 4th-largest holding at 9.0% of this ETF’s 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” an incredible 63.3m ounces of silver! But it also smelted large amounts of zinc, lead, copper, and gold that same year.

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 40.1%.

That’s right in line with the trend over this past year, with Q3’16, Q4’16, Q1’17, and Q2’17 seeing SIL’s top-component silver purity averaging 42.8%, 40.6%, 38.5%, and 37.6%. 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 $168m and $384m 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-November composition was such that there wasn’t a lot of Q3 cost data reported by its top component miners. 4 of its top 5 companies trade in the UK, South Korea, and Mexico, where reporting only comes in half-year increments. Lower down the list there are more half-year reporters, an explorer with no production, and primary gold miners that don’t report silver costs. So silver cost data was scarce.

Nevertheless, it’s always useful to look at the data we have. Industry-wide 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 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 Q3’17, these top 17 SIL-component silver miners that reported cash costs averaged $4.86 per ounce. That plunged a whopping 13.6% YoY, making it look like silver miners are far more efficient.

But that too is misleading. This past quarter SIL’s 17th-largest component was Silvercorp Metals, which enjoys big lead and zinc byproducts at its China silver mines. These base metals are sold and used to offset the costs of silver mining. That forced SVM’s cash costs down to negative $5.16 per ounce, which dragged down SIL’s overall average. A year ago in Q3’16, SVM ranked 18th in SIL and missed the top-17 cutoff.

Still even ex-SVM, these top SIL silver miners reporting cash costs last quarter averaged just $6.54 per ounce. As long as silver prices stay above those extreme levels, the silver miners can keep the lights on. And there’s no way silver is going to plummet down under $7 in any conceivable scenario. So even at 2017’s vexingly-low gold-lagging silver prices, the major silver miners face no existential threats today.

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. AISC 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 Q3’17, these top 17 SIL components reporting AISC averaged just $9.73 per ounce. That was down 3.9% YoY, and far below last quarter’s average silver price of $16.84. Again SVM’s incredible byproduct production dragged down the average though. Ex-Silvercorp, these top SIL silver miners’ AISC ran at an average of $10.98 in Q3. That’s still well below prevailing silver prices, generating nice operating profits.

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. Thus AISC surged at Pan American Silver, First Majestic Silver, and SSR Mining. PAAS discontinued mining at an older mine, while other mines processed lower-grade ore that was on the way to better rock later.

AG’s lower production was due to land-access issues and mine inspections necessary following Mexico’s big earthquakes in mid-September. And of course SSRM is winding down its lone primary silver mine. Yet even with lower production driving higher per-ounce costs, the major silver miners still enjoyed solid operating profits. That’s certainly not apparent based on silver miners’ super-low stock prices mired in bearishness.

At $9.73 AISC, the major silver miners still earned big profits in the third quarter. Once again silver averaged $16.84, implying fat profit margins of $7.11 per ounce or 42%! Most industries would kill for such margins, yet silver-stock investors are always worried silver prices are too low for miners to thrive. That’s why it’s so important to study fundamentals, because technical price action fuels misleading sentiment!

Today’s silver price remains really low relative to prevailing gold levels, which portends huge upside as it mean reverts higher. 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 really under-performing gold so far in 2017, with the SGR averaging just 73.5 YTD as of mid-November. 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 38% above its Q3 average. Assuming the major silver miners’ all-in sustaining costs hold, that implies profits per ounce soaring 90% 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, actual accounting profits, revenues, and cash on hand. They generally corroborated AISC in Q3’17, proving silver miners are weathering low prices.

The collective operating cash flows of these top 17 SIL silver miners slumped 14.4% YoY to $1350m. That’s really impressive considering the 13.9% YoY drop in average silver prices, so these miners are holding their own despite silver really lagging gold this year. GAAP accounting profits looked far worse though, plunging 77% to just $88m. Many of these top SIL silver miners suffered net losses in Q3’17.

That was generally just the result of lower silver prices. There were two outliers, Tahoe Resources and Coeur Mining. With its silver mine temporarily shuttered by Guatemala, TAHO’s profits swung massively from +$63m in Q3’16 to -$8m in Q3’17. That $71m drop alone was responsible for 24% of the YoY drop in these top SIL silver miners’ GAAP profits. CDE simply had higher costs as it worked on expanding mines.

So its profits plunged from +$68m in Q3’16 to -$17m in Q3’17, for an $85m total drop. That accounted for another 29% of the total slide in collective top SIL miners’ profits. Other than that, the YoY declines were reasonable based on the lower silver prices. Interestingly these top 17 SIL miners’ collective sales surged 15.2% YoY to $3003m, driven by their aggregate silver and gold production rising 3.7% and 2.4% YoY.

And despite the weak silver prices, serious operational challenges, and ongoing expansions especially on the gold side of their businesses, these elite SIL miners’ total cash balances only edged 0.1% lower YOY to $2682m. So overall the silver miners’ operating results were pretty good in Q3’17 considering all the big trials they faced. Based on the individual miners’ travails, I was steeling myself for much worse.

Silver miners’ earnings power and thus stock-price upside potential will only grow as silver mean reverts higher. In mining, costs are largely fixed during the mine planning stages. That’s when engineers decide which ore bodies to mine, how to dig to them, and how to process that ore. Quarter after quarter, the same numbers of employees, haul trucks, excavators, and mills are generally used regardless of silver prices.

So 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’ ongoing 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 Q3, this has resulted in 967 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 +19.9%!

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The bottom line is the major silver miners fared fine in Q3 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 Q3’s low prevailing silver prices. And their accelerating gold-production growth 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 current upleg. The silver miners’ profits leverage to rising silver prices remains outstanding. After fleeing silver stocks so aggressively this year, investors and speculators alike will have to do big buying to reestablish silver-mining positions. That will fuel major upside.

Adam Hamilton, CPA

November 24, 2017

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