The silver miners’
stocks have enjoyed an epic year, skyrocketing higher with silver’s
new bull market. At best since mid-January alone, some of these
elite stocks had actually septupled! Naturally such extreme gains
beg the question of whether they can possibly be fundamentally
justified. The recently-released second-quarter financial and
operational results of the top silver miners offer much insight on
this.
Back in
mid-December leading into the Fed’s first rate hike in 9.5 years,
silver was pounded to a dismal 6.4-year secular low.
Sentiment was overwhelmingly bearish, the breeding ground of major
bottomings. Indeed silver soon started climbing with its
primary driver
gold heading into 2016. As usual silver got off to a slow
start, with traders skeptical until gold rallied far enough and long
enough to entice them back.
In Q1’16 silver
really lagged gold, with a weak 11.7% advance to gold’s 16.1%. Once
silver bulls get underway in earnest, silver tends to amplify gold’s
upside by 2x to 3x. And that already started happening in Q2’16,
which saw silver surge 21.4% higher on a mere 7.4% gold rally! This
acceleration is what ignited silver stocks. Was their buying fueled
purely by greed, or did it have real fundamental underpinnings?
This crucial
question for investors couldn’t be addressed until mid-August, when
silver miners’ Q2’16 results were fully released. Publicly-traded
companies in the US are required by the Securities and Exchange
Commission to report their earnings four times per year. The
deadline for filing is 45 days after quarter-ends. I first looked
at gold miners’
Q2 results, then
gold juniors’,
and now it’s silver miners’ turn.
Silver mining is a
tough business 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. According to the venerable Silver
Institute, only 30% of 2015’s global mined supply came from primary
silver mines!
Well over 2/3rds
of the 886.7m ounces mined last year was simply a byproduct of
base-metals and gold mining. And 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. And these often include
non-primary-silver ones, usually gold, to bolster the lower
silver-mining cash flows.
So the universe of
major silver miners is pretty small. The definitive list of these
companies to analyze comes from the most-popular silver-stock
investment vehicle, the SIL Global X Silver Miners ETF. SIL
dominates the silver-stock-ETF space, with net
assets running 5.0x its next largest
competitor’s. Since ETF investing is becoming the new norm,
inclusion in SIL is a major boon for silver-mining companies.
While there aren’t
a ton of silver miners to pick from, major-ETF inclusion shows
silver stocks have been vetted by elite analysts. It also ensures
the fund capital flowing into leading silver-stock ETFs benefits
their components. The ETF managers shunt excess differential buying
pressure on their shares directly into the underlying component
silver miners held by these ETFs, bidding their individual silver
stocks higher.
As of the middle
of this week, SIL included 21 major “silver miners”. This term is
used somewhat loosely, as SIL includes the massive silver streamer
Silver Wheaton that doesn’t actually mine, Mexico’s giant mining
conglomerate Industrias Penoles for which silver is just a minor
byproduct, gold miner Alamos Gold which doesn’t mine any silver, and
MAG Silver which doesn’t have its silver mine in production yet.
Nevertheless SIL
is what we’ve got, so I dug into the Q2’16 10-Q reports released by
this ETF’s top 17 components. That number was chosen because that
many stocks fit neatly into this table below. But with these top 17
SIL components commanding fully 97.2% of
SIL’s total weighting, they are really all that matters. I
collected a bunch of key data from each, and fed it into a
spreadsheet for sector-wide analysis.
This table starts
with market-level information including each SIL component’s stock
symbol, exchange traded on, current weighting in SIL, and market
capitalization. After that is a critical metric for investors
looking for purer silver-mining exposure, the percentage of each
company’s quarterly sales that actually came from silver mining.
Silver-stock investors generally want silver exposure, not gold or
base metals.
The formula for
this silver-percentage approximation is simple. Each company’s
Q2’16 silver production is multiplied by that quarter’s average
silver price, and the result divided by total quarterly revenue.
This number isn’t perfect, it can be skewed. Sometimes silver
miners sell more or less silver in a quarter than they produced, due
to the timing of actual sales. Byproducts and hedging can also pull
this number around.
The true
primary silver miners that derived over half their Q2’16
revenues from silver have percentages highlighted in blue. That
column is followed by cash costs per ounce of silver mined, all-in
sustaining costs per ounce, and AISC guidance for full-year 2016.
Next comes quarter-end cash balances and the cash flows generated
from operations in Q2’16. Finally last quarter’s silver and gold
production is noted.
Provocatively
there isn’t a single major silver miner today that doesn’t generate
a large portion of its total sales from gold mining. That’s
both as a byproduct in silver mines and in separate primary gold
mines the silver miners also own. Pure silver miners don’t exist!
Depending on your view, they are either all augmented by gold or
adulterated with it. That helped silver miners’ fundamentals
improve dramatically in Q2’16.
When I last did
this top-SIL-component analysis using
Q1’16 data
several months ago, 7 stocks qualified as primary silver miners with
over half their quarterly sales from silver. All of the top 17 SIL
components that provided enough data to compute their silver
percentages averaged out to 44.9%. I figured that as silver’s gains
started outpacing gold’s, these key numbers would rise. But they
were essentially flat in Q2’16.
Only
6 of the top 17 SIL components generated
50%+ of their revenues from silver last quarter, and the
average only rose modestly to 45.3%. This
may sound rather odd considering silver’s average price rose 12.7%
sequentially from Q1 to Q2, compared to just 6.3% for gold’s. That
didn’t translate into a higher overall silver percentage because
these silver miners collectively increased their gold output
quarter-on-quarter.
Overall silver
production of these top miners
impressively rose 4.6% in Q2 compared to Q1, to 77,852k ounces.
But their collective gold production growth even exceeded
that, up 6.1%
quarter-on-quarter to 1273k. Silver miners’ outpacing gold-mining
growth was driven by their active diversification into gold. The
cash flows from silver mining are rarely spectacular, since silver’s
price is always low relative to gold’s.
And
that perpetual disparity of cash flows between silver and gold
mining ballooned to gaping extremes in the recent dark years. As
silver languished near major secular lows, silver miners sought to
augment their cash flows by buying gold mines. Naturally
this process takes time, as it isn’t easy to find a suitable
acquisition target, prepare and execute the purchase, and integrate
the new mine into current operations.
This trend is far
from over, as gold mining’s far-higher cash flows really reduce the
operational risks of silver mining. Tahoe Resources is a prime
example. Spun off by Goldcorp as a totally-pure silver miner
operating one of the world’s largest silver mines, Tahoe bought the
gold miner Lake Shore Gold and is now overwhelmingly a primary
gold producer in terms of revenue. Silver purity is fading
among its miners.
Since some of
these elite silver miners use gold as a byproduct credit, its sales
directly reduce the costs of mining silver. This is evident in
silver miners’ costs last quarter, which fell considerably. Cash
costs are the classic way to measure silver-mining costs. They
include all direct production costs of mining silver, mine-level
administration, smelting, refining, transport, regulatory, royalty,
and tax expenses.
Cash costs are the
acid-test measure of silver-miner survivability, revealing the
silver levels needed to keep the doors open and pay the bills.
Incredibly in Q2’16, they averaged just $5.32 per ounce! This was
not only far below silver’s $16.79 average price, but a whopping
11.2% lower than Q1’s cash costs. This is almost exclusively due to
higher byproduct credits, primarily gold but also base metals in
some cases.
Far more important
are the elite silver miners’ all-in sustaining costs. This
vastly-superior measure was introduced in June 2013 by the World
Gold Council. In addition to all direct cash costs, AISC also add
on everything necessary to maintain and replenish operations
at current silver-production levels. This includes exploration for
new silver to mine, mine development and construction, remediation,
and reclamation.
All-in sustaining
costs also include the critical corporate-level administration that
oversees silver-mining operations. In Q2’16, the top 17 SIL silver
miners reporting AISC had average levels
of just $10.05 per ounce. That’s 2.2% better than Q1’s average,
but far more importantly way below that $16.79 average silver price
in Q2. That implies the silver-mining industry’s operating
margins have soared to
$6.74 per ounce.
That’s a
staggering 46% jump sequentially in Q2 alone, a massive increase!
This stock-market-leading surge in operating profitability helps
explain why silver stocks were bid sharply higher in Q2. Profits
ultimately drive stock-price levels, and silver-mining profits were
exploding as silver’s new bull started to accelerate. The sole
reason investors own silver stocks is for their great profits
leverage relative to silver.
Silver mining
costs are essentially fixed in the mine-planning stages. That’s
when mining engineers decide which ore bodies to extract, how to dig
to them, and how to process that ore to recover the silver. The
vast majority of these costs of moving and processing rock are
fixed, they don’t change much no matter what silver’s price does.
This ensures silver-mining profits soar far faster than silver’s own
gains.
At AISC near $10
per ounce, silver miners earned about $7 in Q2’16. Yet so far in
Q3, silver’s average price has powered up
another 17% to $19.69. Thus silver-mining operating profits
are likely now up near $10 per ounce,
another 43% gain! The higher silver runs, the greater
the profits growth the silver miners will enjoy. And silver remains
relatively low, with its
young bull market
still having lots of room to soar.
Back in 2012 for
example before the Fed’s wildly-unprecedented open-ended third
quantitative-easing campaign started
grossly
distorting the markets, silver averaged $31.19. While
that’s only another 58% higher from
Q3’16’s average price, such silver gains would fuel a
gargantuan 219% jump in operating profits from Q3 levels! The
underlying fundamentals of mining silver definitely support big
stock-price gains.
These
rapidly-improving silver-mining fundamentals are readily evident in
silver miners’ operating cash flows and cash balances. Cash flows
from operations are the best proxy of current profitability,
as the trailing-twelve-month price-to-earnings ratios of silver
miners are now extremely distorted by
huge non-cash
writedowns. These accounting-construct losses flared in late
2015 thanks to silver’s deep secular lows.
One of the core
tenets of accounting is conservatism, which demands companies
anticipate possible future losses but not gains. So Q4’15’s low
silver prices had to be assumed to persist indefinitely, slashing
the economic value of silver mines and deposits. These were written
down, with resulting non-cash losses flushed through income
statements. Until these writedowns roll off trailing P/Es, they
will mask real profits.
Quarterly cash
flows generated from operations are the purest measure of actual
profitability, avoiding all the short-term accounting fictions
inherent in the GAAP earnings that feed P/E ratios. And in Q2’16,
these elite top SIL components’ operating cash flows skyrocketed a
mind-boggling 135% quarter-on-quarter
to $1449m! This is truly all the fundamental justification
silver stocks need for their massive Q2 gains.
These
radically-higher operating profits naturally fed growing cash hoards
among the top silver miners. Their total cash on hand at quarter-end
soared 69.6% sequentially between Q1 and Q2 to $3537m! This
proves that there was far more than greedy sentiment underlying
silver stocks’ epic gains so far this year. This young new silver
bull has already vastly improved the economics of extracting this
precious metal.
Unfortunately most
investors don’t yet understand what’s going on in the silver-mining
realm. Not many even pay attention to contrarian investments like
silver stocks. And many of those who do are scared of the silver
miners’ super-high or nonexistent trailing-twelve-month P/E ratios.
They don’t realize that once last year’s big non-cash writedowns
roll off the latest 4 quarters, silver-mining P/E ratios are
going to collapse.
By the time
trailing P/Es reflect true ongoing operating profitability in future
quarters, the silver stocks will have surged much higher than
today’s levels. Digging deep into quarterly reports is necessary to
really understand what’s going on in an industry, as trailing
valuation metrics mask major reversals in fortune for up to a
year. Silver miners’ immense growth in operating profitability
remains hidden to all but a few.
Another thing
investors must consider is where the silver stocks came from. Since
gold drives silver, the silver stocks follow the gold stocks. Back
in mid-January, the leading gold-stock index slumped to a truly
fundamentally-absurd 13.5-year secular low. As I warned that
very week, it was ludicrous for gold stocks to be trading as if gold
was near $305 when it was actually way up at $1087! Silver stocks
were sucked in.
Precious-metals
sentiment was so overwhelmingly bearish that silver stocks were
trading as if they were on the verge of bankruptcy. That was a
silly assertion even then, as their cash costs and even all-in
sustaining costs were well below even silver’s deep secular lows.
Silver stocks had to mean revert much higher out of such
unsustainable extremes, and that’s exactly what has happened so far
in 2016.
So when silver
stocks’ enormous year-to-date gains are considered, it’s critical to
realize they emerged out of some of the most-extreme silver-stock
lows ever witnessed. This year’s mighty rallies were born in
epic fear, not mounting greed leading into a topping after a long
bull. Since a huge mean reversion higher out of such extremes was
inevitable, silver miners’ fundamental justification is just icing
on the cake.
Silver miners’
latest quarterly results recently released for Q2 prove that they
are not only fundamentally strong today, but rapidly
strengthening. This entire industry that was left for dead in
late 2015 is going to see some of the best operating-profits growth
by far in all the stock markets in 2016, helping to justify the epic
gains in silver-stock prices this year. They are rooted in real
profits growth, not ethereal sentiment.
As silver-stock
prices continue to rise in coming quarters, fueled by soaring
earnings driven by higher silver prices, great gains are still to be
won. While SIL is fine, the largest gains will be witnessed in
individual silver stocks with superior fundamentals.
Investors need to look for the elite miners with the best
combination of percentage of revenues from silver, operating
margins, and coming silver-production expansions.
And man, what an
incredible gift this past month’s sharp silver-stock correction is!
Many of the world’s best silver stocks were pummeled 20% to 30%
lower since their latest bull highs in early August. They are now
on sale at deep discounts, wonderful buying opportunities. If you
liked silver stocks a month ago when everyone else did, you should
love them today at far-superior entry prices. Talk about a great
boon.
At Zeal we’ve
spent literally tens of thousands of hours researching
individual silver stocks and markets, so we can better decide what
to trade and when. This has resulted in
844 stock trades recommended in real-time for our newsletter
subscribers since 2001. Their average
annualized realized gains including all losers are running way up at
+23.4%! And that’s excluding big unrealized gains on our
books today.
Despite the sharp
correction, we still have plenty of doubles this year alone. We
also have a major new gold-stock and silver-stock deployment well
underway to ride the coming uplegs, as it’s a great time to buy
relatively low. You can read about our new trades and market timing
in our acclaimed
weekly and
monthly newsletters. They draw on our 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.
Subscribe today!
For just $10 an issue, you can learn to think, trade, and thrive
like a contrarian.
The bottom line is
the major silver miners just reported an amazing Q2’16, with
silver’s young new bull fueling radically-higher operating
earnings. The great inherent leverage of silver-mining profits to
silver prices was the fundamental justification underlying silver
stocks’ epic gains so far this year. And with silver’s bull only
just starting, the best gains in silver-mining profitability and
thus stock prices are yet to come.
Unfortunately most
investors don’t yet realize what’s going on fundamentally. They see
silver miners’ extreme or non-existent price-to-earnings ratios and
assume this industry is really struggling. But once last year’s
massive non-cash writedowns of silver-mining assets roll off the
books, the silver miners’ big operating profitability will be
reflected in conventional valuations. Smart investors will be fully
deployed long before.
|