The silver miners
recently finished reporting their third-quarter results, offering a
hard fundamental look into this sector. This reality check is
valuable given the fierce winds of bearish sentiment buffeting
silver stocks in recent months. Despite their huge correction, the
elite silver miners’ fundamentals remain strong. They are producing
at costs far below prevailing silver levels, with profits poised to
soar as silver recovers.
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. 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 4.8x 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
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 stock
prices higher.
As of mid-November
when silver miners finished reporting their Q3 results, SIL included
24 major “silver miners”. This term is used somewhat loosely, as
SIL includes plenty of companies that simply can’t be described as
primary silver miners. Most generate well under half their
revenues from silver, greatly limiting their stocks’ upside to
silver-price increases. One is even a gold miner that doesn’t
report any silver production!
I’ve been a
silver-stock investor and speculator for decades, and my biggest
reservation about SIL is its heavy weighting of metals other than
silver. When traders buy a “Silver Miners ETF” which is what SIL
advertises itself as, they expect to get silver miners with
natural upside leverage to silver gains. While pure silver miners
are nonexistent due to the geology and economics of silver mining,
SIL could do better.
The greater the
percentage of revenues any miner derives from silver, naturally the
higher its silver-price exposure. If a company only earns 20%, 30%,
or even 40% of its sales from silver mining, it’s definitely not a
primary silver miner. Technically that designation should just
apply to miners deriving at least half of their revenues from
silver production. SIL’s managers could build a far-superior ETF if
they stuck to that rule.
This leading
silver-stock ETF has long been dominated by primary gold miners and
even worse mining conglomerates. Because these non-primary-silver
miners generate only relatively-minor fractions of their sales from
silver, their stock prices aren’t very responsive to silver-price
moves. SIL shareholders would be far better served by replacing
these inappropriate components with smaller primary silver miners.
Nevertheless SIL
is what we’ve got, so I’ve spent recent weeks digging into the Q3’16
10-Q reports filed by this ETF’s top 17 components. That number was
chosen because that many stocks fit neatly into the table below.
But as these silver miners command fully 95.5% of SIL’s weighting,
they are essentially all that matters. Every quarter I collect a
bunch of key data for each, and feed it into a spreadsheet for
analysis.
Some of that data
made it into the following table. If a field is blank, the company
didn’t report that data for Q3. SIL includes foreign miners trading
in Mexico and the UK, where publicly-traded companies are only
required to report in half-year increments instead of
quarterly. So they generally don’t release any detailed financial
information for Q1s and Q3s. They do tend to report on production
though, which is helpful.
The first couple
columns show each SIL component’s symbol and weighting in SIL as of
the middle of November when Q3 reporting finished. If you can’t
find a symbol here in the States, it is a listing from a company’s
primary foreign stock exchange. That’s followed by each company’s
Q3 silver production, along with its quarter-on-quarter change from
Q2. That’s probably more relevant than year-over-year today.
With a major
new silver bull
market underway in 2016, this year has proved radically
different for silver miners than last year which was mired deep in a
bear market. Thus traditional YoY comparisons are so distorted that
sequential QoQ ones make more sense today. Bull years don’t compare
well with bear years and vice versa. Once silver’s young bull is a
couple years old, then we can switch back to YoY analysis.
Q3’16 silver
production is followed by gold production. Every single top silver
miner included in SIL also produces significant if not large amounts
of gold! While gold stabilizes silver miners’ cash flows, it also
retards their stocks’ sensitivity to silver itself. Silver-stock
investors and speculators need to know how pure silver miners
really are. So I included another column showing each SIL
component’s percentage of silver.
This is mostly
calculated by taking a company’s Q3 silver production, multiplying
it by the average silver price in Q3, and dividing that number by
the company’s total quarterly sales. In a couple cases where miners
didn’t report Q3 revenues, I approximated them by adding the silver
sales to gold sales based on quarterly production and Q3’s average
gold price. Either way, it reveals how focused on silver these
companies are.
That’s followed by
cash costs and all-in sustaining costs per ounce of silver
produced. They reveal just how profitable silver miners are and how
easily they can weather silver corrections. Finally operating cash
flows generated in Q3 are shown, which are the best proxy for how
silver miners are currently faring. Some of the elite silver miners
included in SIL enjoyed amazing quarterly gains in operating
profitability.
Compared to
everything else including gold, silver is a tiny market. The
world authorities on supply and demand in each are the World Gold
Council and Silver Institute. Using their respective numbers on
global demand last year, world silver demand was worth just $13.9b
compared to $162.0b for gold! With silver’s market only about
1/12th the size of gold’s, there is a lot less interest in and data
available on silver.
Together these top
17 SIL components produced 76.2m ounces of silver in Q3. Annualize
that, and it equates to 304.8m or about 34% of 2015’s global silver
mine production. But that’s misleading too, as the largest silver
miners included in SIL definitely aren’t primary silver miners. The
top 3 in Q3 were led by Mexican mining conglomerates Industrias
Penoles and Fresnillo, closely followed by the UK’s Polymetal.
Despite their huge
absolute silver production, silver is just a minor overall byproduct
for Penoles and Polymetal. Their silver production in Q3 was
responsible for just 26% and 30% of their total revenues! Neither
should be included in SIL, because their small silver percentages
render their stock prices very unresponsive to silver. Fresnillo
didn’t provide enough data to calculate for Q3, but in Q2 it ran a
respectable 49%.
Now you could
definitely argue that companies deriving over 40% of their revenues
from silver qualify as silver miners, but anything under that seems
pretty questionable. Investors buy silver-stock ETFs solely because
they want mining profits leveraged to silver-price upside.
SIL’s managers really ought to take that into consideration.
Including so many non-primary miners really dilutes SIL’s usefulness
to investors.
SIL’s 9th-largest
component in mid-November, Alamos Gold, actually reports zero
silver production! It should be kicked out in favor of the smaller
silver miners that didn’t make the top 17. Two other SIL
components, Klondex Mines and McEwen Mining, produce so little
silver that they don’t even report silver costs. SIL really needs
to establish at least a 40% silver threshold to live up to its
billing as “Silver Miners ETF”.
Interestingly
SIL’s top 17 component companies actually saw silver production fall
2.1% QoQ, which is fairly steep. But this entire sequential drop
came from sharp production declines in those big Mexican mining
conglomerates Penoles and Fresnillo. Without them, the other top 15
SIL component companies actually saw silver production grow 1.3%
QoQ. But gold production grew even more, diluting silver
percentages.
The average QoQ
growth rate in these elite SIL components’ silver production ran
just 1.5% in Q3, way behind their average 8.7% gold-production
growth! That helped drive their average percentage of sales
generated by silver down from 45.3% in Q2 to 42.8% in Q3. On the
bright side, SIL’s top 17 companies still included 6 that were
definitely primary silver miners with 50%+ of their revenues derived
from silver.
Their silver
percentages are highlighted in blue in this table. Investors
looking for pure silver miners with profits and therefore stock
prices heavily levered to silver would do far better owning
some combination of these individual stocks rather than SIL. A
common problem among all sector ETFs is the upside of the best
stocks they hold is retarded by the lower performances from laggard
peers, reducing gains.
That’s why I’ve
always preferred
handpicking the best individual stocks to own in a sector
instead of settling for an ETF’s over-diversified holdings. While
ETFs like SIL usually contain the best a sector has to offer, they
are also burdened with many underperforming companies in a
somewhat-misguided quest for diversification. While diversification
indeed reduces risk, it also reduces reward. It is a
double-edged sword.
Understanding how
the elite silver miners fared fundamentally in Q3 requires looking
at their costs. The classic way to measure these is cash costs
per ounce. They include all direct production costs of mining
silver, mine-level administration, smelting, refining, transport,
regulatory, royalty, and tax expenses. They are the acid-test
measure of silver-miner survivability, revealing silver prices
necessary to keep the doors open.
In Q3’16, the top
17 SIL component stocks that reported silver cash costs averaged
$5.63. That proved a steep 5.8% QoQ jump from Q2’s $5.32. I
suspect this was partially due to Q3’s sharply-higher average silver
prices. They averaged $19.55 last quarter, a whopping 16.4% higher
than Q2’s $16.79! That was silver’s best quarter in a couple years,
since Q3’14. That gave silver miners some breathing room on grades.
Silver deposits
certainly aren’t homogeneous, with different areas in the same ore
bodies having major variations in silver mineralization. Miners
often have to dig through lower-grade ore to get to higher-grade ore
underneath. They can sometimes alter their mining plans to take
advantage of higher prices by mixing in lower-grade ore that has to
be eventually mined anyway with higher-grade ore, raising costs.
Since the
throughput of mines’ mills which process the ore is essentially
fixed, lower-grade ore results in lower quarterly production. That
spreads the big fixed costs of mining across fewer ounces, pushing
up per-ounce costs. It is not clear that’s what actually happened
in Q3, as most of the elite silver miners had higher
quarterly silver production than Q2. But higher silver prices
generally facilitate higher costs.
That happened to a
lesser extent in all-in sustaining costs too, a far-superior
cost measure introduced by the World Gold Council in June 2013.
AISC give investors a much-better understanding of what it actually
costs to maintain a silver mine as an ongoing concern. They include
all direct cash costs, but then add on everything else 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 administrative expenses necessary to oversee silver
mines. All-in sustaining costs are the most-important silver-mining
cost metric by far for investors, revealing miners’ true
operating profitability.
In Q3 these top 17
SIL companies which reported AISC averaged an impressive $10.13 per
ounce! As long as the silver price stays above
all-in-sustaining-cost levels, the silver miners can operate
indefinitely. This shows how overdone the bearish silver-stock
psychology has been since the election, with silver’s lowest price
seen in Q4 still way up at $16.36. These
are still very-profitable levels for elite major silver
miners.
Q3’s AISC among
these SIL miners rose a modest 0.8% from Q2’16’s $10.05, much less
than the 5.8% QoQ jump in cash costs. The fact the silver miners
held the line on all-important AISC despite sharply-higher silver
prices is very impressive. That helped generate big operating
profitability. On average the elite silver miners were earning
$9.42 per ounce in profits with silver’s $19.55 average price seen
in Q3!
This was a
whopping 39.8% higher than the $6.74 margin earned in Q2 when silver
averaged $16.79, nicely leveraging the 16.4% jump in average silver
prices quarter-on-quarter! Silver miners’ big inherent profits
leverage to silver is the primary reason investors want to own these
stocks. The more of any miner’s sales are driven by silver, the
greater its profits leverage to the white metal and thus the bigger
its stock’s upside.
These strong
margins naturally fed big growth in cash flows generated from
operations, the best read on current operating profitability. On
average the top 17 SIL component silver miners that reported
financial results in Q3 saw strong 19.6% QoQ operating-cash-flows
growth! This is very impressive, certainly way up among the best
sectors in all the stock markets. Silver-stock fundamentals
supported surging prices.
Because of the
half-year reporting by foreign silver miners, a straight comparison
of the total operating cash flows of these top 17 SIL components
isn’t righteous. But as Polymetal and Hochschild didn’t break out
Q2’16 operating cash flows in time for
my last analysis
on silver stocks either, we only have to exclude Fresnillo. It
reported Q2’16 operating cash flows as part of half-year results,
but didn’t report Q3’s.
Without Fresnillo,
these top SIL-component companies collectively generated $1577m in
operating cash flows in Q3. This was 30.2% higher than Q2’16’s
total ex-Fresnillo! Seeing an entire industry’s cash flows
generated from operations surge by nearly a third sequentially
in a single quarter is amazing. This even beat the
major gold
miners’ gains, showing why investors flock to silver stocks
during silver bulls.
On an actual
accounting-profits basis, which isn’t shown in this table, SIL’s top
17 silver miners ex-Fresnillo earned $382m in Q3 compared to $301m
in Q2. That is hefty 26.9% QoQ growth in earnings! Can you imagine
Wall Street beating down the doors to flood into any other sector
where something like this occurred? The fundamental improvement in
silver miners this year has been nothing short of enormous.
But today
silver-stock investors and speculators are ignoring the miners’
strong Q3 results to get caught up in the bearish prevailing
sentiment. Silver has been hit hard in Q4 due to
heavy
gold-futures selling in early October and then again after
early November’s election. So far in Q4, silver has only averaged
$17.59. That’s down 10.0% from Q3’s $19.55. Does the
fundamental impact justify the sharp silver-stock selloff?
Let’s
conservatively assume that silver doesn’t bounce even though a big
rebound higher is overdue, so Q4-to-date’s average silver price will
hold until year-end. If the silver miners can maintain Q3’s $10.13
AISC, that yields profit margins of $7.46 per ounce. While 20.8%
lower than Q3’s $9.42, that still leaves silver mining very
profitable. The sharp drops in silver-stock prices in recent
months have dwarfed that impact.
As measured by
SIL, the silver stocks peaked in mid-August. Since
then, SIL has plunged 36.6% at worst! And
that significantly understates recent months’ downside in
primary silver miners, since SIL’s higher weightings are commanded
by non-primary silver producers. So it’s definitely safe to say
that the recent plunge in silver-stock prices is nearly double
the probable fundamental impact of Q4’s lower silver levels!
Thus the recent
silver-stock correction is wildly overdone compared to underlying
fundamentals. Like usual when sentiment swings against silver
stocks, investors and speculators have gotten caught up in the
popular bearishness and forgotten about fundamental reality.
The silver miners’ strong Q3 results are a big wake-up call. The
silver miners’ fundamentals have strengthened dramatically on
silver’s new bull.
And that is far
from over. The post-election silver plunge was driven by heavy
gold-futures selling which sucked silver in. But that extreme gold
selling was anomalous and
will soon reverse.
Sooner or later the
overvalued stock
markets’ euphoria at the prospects of fiscal stimulus will be
shattered by the hard realities of actually getting it done. As
stock markets inevitably roll over, gold and silver will catch major
bids.
Once
undervalued
silver starts powering higher again, capital will flood back
into the beaten-down silver stocks catapulting their prices higher.
The silver miners’ operating profitability improves massively during
silver bulls, so their huge silver-stock upside is totally
justified fundamentally. The anomalous post-election
silver-stock plunge is an incredible buy-low opportunity on
excessively-bearish psychology.
At Zeal we’ve
spent decades researching and trading silver stocks, with excellent
results. As of the end of Q3, all 851 stock trades recommended to
our newsletter subscribers in real-time since 2001 averaged stellar
annualized realized gains of +24.1% including all losers! That’s an
order of magnitude greater than the general stock markets’
performance over that span. Achieving it required staying focused
no matter what.
Sadly most
investors and speculators lose interest in silver stocks the moment
they correct hard. So they foolishly bury their heads in the sand.
Big gains are only possible by staying informed all the time.
Only that will ensure you are aware when silver stocks
are screaming
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The bottom line is
the major silver miners’ recently-reported Q3’16 fundamentals were
incredibly strong and bullish. Stable all-in sustaining costs
combined with sharply-higher silver prices drove explosive growth in
operating cash flows and accounting profitability. The fundamental
transformation the silver stocks have undergone in 2016 has been
amazing, and it is only starting as silver’s new bull remains young.
But unfortunately
most investors and speculators today aren’t paying attention to the
silver miners’ strong fundamentals. Instead they are all wrapped up
in the fearful prevailing sentiment. That’s a big mistake as
always. While silver-mining operating profitability will decrease
in Q4 if silver prices remain low, that will be short-lived before
silver’s bull resumes. Higher silver will fuel far-higher
silver-stock levels. |