|
|
The new normal could be $75/oz. silver. In this
exclusive interview with The Gold Report, David Morgan, editor of The
Morgan Report, maps out a path for silver that could sink as low as
$5/ounce (oz.) during the summer pullback and then bounce up to $75/oz. to
establish a new base level. A consistent Silver Institute Production Cost
Standard could help investors make smarter decisions during the coming
upswing.
Companies Mentioned: First Majestic Silver Corp. - Franco-Nevada Corp.- Royal Gold Inc.
The Gold Report: In your Morgan Report, you have written
extensively about the impact of global financial issues on gold and silver
prices. At least temporary solutions have been found for the euro-Greek
tragedy and the U.S. debt limit debacle. Will this give the U.S. dollar a
boost at the expense of precious metals?
David Morgan: It is getting more difficult to predict what the market
reaction will be to specific events. As people figure out that there really
is no solution to the global financial system without a great deal of pain
and some defaults along the road, more will seek the safety of precious
metals. So, even when things calm down for the moment, it does not mean the
precious metals will not get pushed down. You could see gold and silver react
to the downside, perhaps dramatically—$5/ounce (oz.) silver is not
entirely out of the realm of possibility. My best guess is we will see some
pullback going into mid-August.
TGR: Today, gold hit $1,700/oz. during what is normally a summer slow
season. Can this climb continue? What are the drivers?
DM: Yes, it can continue and the driver is uncertainty. Look at all
the problems in the currency markets. It seems interbank lending is starting
to freeze up in Europe. This was one of the main factors contributing to the
financial crisis of 2008. So there is much to consider and it boils down to
the fact we are in the final stages of a currency
depreciation on a global basis.
TGR: A lot of the economic indicators—GDP and consumer
confidence, in particular—are coming in weaker than expected, not to
mention the Standard and Poor's downgrade of U.S. debt. Could we see another
2008-style sell-off, and how would that impact precious metals?
DM: Fundamentally, nothing of substance has changed since 2007 except
that the banks have lots of money on hand. You have to understand that the
silver market has a mind of its own. What happened in 2008 was a silver
sell-off that caused a shortage, pushing the physical price of silver at the
retail level to around $13/oz. while paper silver traded under $9/oz. on the
futures exchanges. Excessive short selling then ran the price from about the
$20/oz. level to the brink of $50/oz. The next leg up could take out the
$50/oz. level after a few tries and then not look back until establishing a
new nominal level of $65/oz.–$75/oz.
TGR: Where is the demand for silver coming from? Is it industrial or
investment-driven? Is the developed or developing world pushing the market?
DM: Look East. In July, the Hong Kong Mercantile Exchange launched a U.S.
dollar-denominated silver futures contract. It cited "surging
international demand for silver" as the cause for the launch, pointing
out that silver demand rose 67% domestically between 2008 and 2010. China
accounted for almost 23% of the world's silver usage last year. It is now
using four times as much silver per-person as it did 12 years ago, but this
is still one-fifth the amount used on a per-person basis in the U.S. and
Canada. Silver demand is growing for both industry and as an investment.
The game has changed, however. The physical market is gaining control
day-to-day and the bankers are finding it more difficult to persuade the
market in their favor. This will only add to the volatility.
TGR: How will the new Silver Institute standard help investors assess
production cost accounting and make smarter investment decisions?
DM: The silver version of the Gold Institute Revised Production Cost
Standard is an attempt to create an apples-to-apples yardstick for silver
production across the sector. In the past, companies used different metrics
to arrive at cost/oz. estimates. Some excluded royalties, while others
ignored shipping refining costs. A significant benefit of the new cost
standard is that it helps clarify the use of silver equivalent/gold equivalent
ounces jargon. About 70% of silver extraction comes as a result of base
metals production. But what happens when a company with very little silver on
its property decides to report its silver equivalent ounces? Theoretically,
the property could be devoid of silver and still use this term by assigning a
"silver value" to its base metals. The silver standard should
eliminate that practice.
The standard is a general accounting system. So, by definition, it will not
fully address all circumstances that producers in the sector might face. For
example, a "pure" silver producer with relatively low base metals
production in relation to silver ounces will not be able to post a
significant base metals figure under the "byproduct credits" entry.
And given that the refinement cost of base metals can be substantially higher
(up to 40%) than for silver ore, this disparity could work against a given
producer when "Total Production Costs" are tallied. Other
disparities that might arise can happen when looking at "payable versus
produced" ounces, taxation/shipping costs on the export of doré versus silver concentrate, etc.
The standards are also voluntary. Time will only tell how consistently this
reporting process will be followed. It was widely embraced on the gold side.
Early indications should be evident this fall, when silver producers begin
filing their third-quarter financial statements. However, if investors feel
it helps them clarify how much profit a silver producer actually makes from
its operations, then it is likely to become a de facto yardstick in
such matters.
One word of caution. This, or any measurement tool, should never be thought
of as a yardstick that will lead to an investment go/no-go decision. Even
assuming that this metric gave a totally accurate picture of a company's
silver production costs, it would be unwise to "pull the trigger"
just because Company A showed a lower production cost than Company B. What if
your lowest cost-of-production company gets nationalized? How about the
effects of a major mineshaft collapse on production? I'm just saying that the
path to high-probability investment decisions depends on a multiplicity of
factors, assigning subjective weighting to each, and then accepting a certain
level of risk to compensate for unknowns, no matter how the numbers stack up.
Therefore, the more factors that jibe, the more likely one is to have arrived
at a "profitable" trading consideration.
TGR: Can you give us an example of how to look at a company's
reporting?
DM: In 2010, First Majestic Silver Corp. (TSX:FR; NYSE:AG; Fkft:FMV) was the top-performing silver company partially as
a result of reporting total production at 93% pure silver. This also made the
company the purest silver producer in the world (so far in 2011 the
percentage is 97%). Due to the high silver purity, mining costs are less
likely to be artificially skewed and reflect the costs associated with a true
low-cost producer.
Some silver producers record net revenue in the sales figure, which is net of
smelter and transportation fees. The net figure includes sales of both silver
and byproducts, and is stated in revenue per ton and costs per ton—a
methodology that makes sense because most silver production is a byproduct of
base metals retrieval. In this case, if the smelting charges are, say, 40% of
the credit value, and are recorded separately, then it would give the
appearance that the credits were providing a higher net value than was
actually the case. Continuing with this scenario, it would be best to
disclose the non-silver production as a credit, rather than as silver
equivalent.
TGR: What is another way investors can have exposure to a variety of
precious metals?
DM: Royal Gold,
Inc. (TSX:RGL; NASDAQ:RGLD) is a leading precious metals royalty company that
owns and manages royalties primarily on precious metals mines with a focus on
gold. The company's royalty portfolio provides investors with a unique
opportunity to capture value in the precious metals sector without incurring
many of the costs and risks associated with mine operations. Royal Gold is an
ideal investment vehicle for exposure to gold and other minerals, absent most
of the inherent mining risk in your average gold miner.
Royal Gold offers leverage to the gold price, unlike many of the gold ETFs
out there, while also providing a much higher dividend, relative to the
industry average. It encompasses all the characteristics of a truly dynamic
company, owning interests in 59 producing and development assets, geographic
diversification, long-lived assets, fixed-cost structure and attractive
valuation.
Like Franco-Nevada
Corp. (TSX:FNV), Royal Gold has also embraced an aggressive
acquisition strategy in the midst of unprecedented worldwide currency
debasement. Royal Gold has near, intermediate and long-term production growth
as well as longer-lived assets on its cornerstone projects based on current
reserves.
Royal Gold has meaningful interests in some of the premier mineral deposits
around the world with regard to gold, silver, copper and other base metals.
Additionally, management believes in its products, which is more than can be
said of the majority of operators, and it has proven so by way of spending
more than a billion dollars in 2010 alone and is likely to continue as deals
present themselves.
Royal Gold has also been on a buying streak. It purchased Teck Cominco, a
diversified mining company and proven operator, that found itself
in financial distress after the 2008 crash. Teck's Chilean Andacollo Mine is
primarily a copper mine, but it possesses significant gold
byproduct—approximately 55 thousand ounces (Koz.) annually for 20 years
based on current reserves. This amounts to just over 41 Koz. annually payable to Royal Gold, more if the company can
optimize milling operations and increase throughput. The present value of
this royalty alone, using $1,550/oz. gold discounted at 8%, equates to nearly
$60M, or $10.97 per share. Royal Gold also purchased International Royalty's
(IRC) portfolio of 85 royalties on 79 properties. The present value of IRC's
Pascua-Lama alone is nearly $600M, or $10.78 per share, using $1,550/oz. gold
discounted at 8%. Completing the transformation, Royal Gold acquired its
first streaming royalty in Mt. Milligan. This 25% streaming interest will
become its largest single asset, contributing approximately 65 Koz. annually at an ongoing cost of $400/oz. Royal Gold has
structured its cornerstone assets in mining-friendly countries, allowing
investors to sleep easier at night. Using $1,550/oz. gold discounted at 8%,
the present value is $799M, or $14.40 per share.
TGR: Those are great examples, David. Any final thoughts you would
like to leave our readers?
DM: Yes, as economic times continue on a path of increasing stress it
is a great time for people to reflect upon true wealth. The old adage that
the best things in life are free is a bit naïve in my book. Nonetheless,
people can reflect upon family, character, health, contribution and all the
things that make us human. Perhaps you could do a thought experiment and ask,
“What are the 10 things I value the most that do NOT involve money?”
TGR: Thank you for taking the time to share your ideas with our
readers.
DM: Thank you.
David
Morgan (Silver-Investor.com) is a widely recognized analyst in the precious
metals industry and consults for hedge funds, high net worth investors,
mining companies, depositories and bullion dealers. He is the publisher of
The Morgan Report on precious metals, author of "Get the Skinny on
Silver Investing" (Morgan James Publishing, 2009), and featured speaker
at investment conferences in North America, Europe and Asia.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when
new articles have been published. To see a list of recent interviews with
industry analysts and commentators, visit our Exclusive Interviews page.
DISCLOSURE:
1) Sally Lowder of The Gold Report conducted this interview. She
personally and/or her family own shares of the following companies mentioned
in this interview: None.
2) The following companies mentioned in the interview are sponsors of The
Gold Report: Franco-Nevada Corp. and Royal Gold Inc.
3) David Morgan: I personally and/or my family own shares of the following
companies mentioned in this interview: Franco-Nevada, First Majestic, Royal
Gold. I personally and/or my family am paid by the
following companies mentioned in this interview: None.
|
|
