Silver has been called the most volatile of metals. But volatility produces opportunity, according to Chris Thompson, a top-ranked StarMine analyst with Haywood Securities. In this exclusive interview with The Gold Report, Thompson forecasts a strong year-end for the devil's metal, despite price weakness so far in Q2/12.
The Gold Report: Chris, Haywood Securities' estimated silver price for 2012 is $36/ounce (oz), but the "devil's metal" has averaged less so far in 2012, closing above $36/oz only once. Are you expecting a significantly stronger second half for silver?
Chris Thompson: Silver performed relatively well in Q1/12. We hope that the silver price will find support at current levels of ~$28/oz through Q2/12 and Q3/12, with potential for a strong Q4/12.
Looking at the silver price right now, I see that it's struggling to hold its head above $28/oz. If we do see a significant breakdown from $28/oz, it may somewhat compromise our forecast for this year averaging $36/oz.
TGR: Do you think investors shy away from the silver space given its overall size and susceptibility to manipulation?
CT: Silver is often referred to as the most volatile of all precious metals. In that sense, it's not for the faint-hearted investor. However, with volatility comes opportunity as long as timing is right. The benefit that silver provides is that it finds value as a store of wealth, as well as an ingredient used in industrial applications, so it offers investors a dual benefit where silver fundamentals benefit from economic growth as well as economic uncertainty.
TGR: In an April 23, 2012, research report, you told investors to "look for quality over quantity" when it comes to silver equities. What makes quality?
CT: A lot of investors look at the size of an in-situ metal resource hosted by a project when looking for a value opportunity presented by exploration and development-stage companies. They tend to ratio that against the enterprise value (EV) of that company to derive a valuation.
Silver is often mined with other metals as by-products. Just recognizing a straight EV dollar/ounces in the ground valuation can be a little misleading. Also, silver is inherently more challenging to recover metallurgically than other precious metals, which influences operating costs and recoveries.
When you layer these peculiarities into the picture, it becomes a complicated story and one that really cannot be valued based on a straight EV dollar/ounce in the ground valuation. We also look at size potential. We look at operating margins on the tonne, as well as jurisdiction. It's a sector where participants should be evaluated on a number of factors rather than just how much silver they have in the ground.
TGR: What sort of opportunities is the volatility creating?
CT: Silver has broken down from its highs in Q1/12. The sector has sold off, which has been exaggerated in some instances. If you're a believer in silver holding its head above the $28/oz mark, opportunities exist where equities have been beaten up more than they should have been based on weakness in the silver price. When the silver price exhibits volatility, volatility in equities is exaggerated, and that creates opportunity.
TGR: The performance of equities has lagged their underlying commodities in the precious metals space for almost 18 months. Why don't the equities respond the same way when the commodity goes up?
CT: We've definitely seen a dislocation between equity valuations and metal price since late 2010. The Toronto Stock Exchange Venture Index is currently at about the same level it was in in the middle of 2010 when the silver price was $17/oz and gold was $1,200/oz. Equities, whether they're exploration, development or even cash-flowing equities, haven't reflected strength in metal prices for some time now.
TGR: They are, but only to the downside.
CT: In the last six months, we have seen a lot of worry and concern about operating costs; capital costs; and jurisdictional, geopolitical and permitting risk. It's not just a story of metal prices anymore. Performance now relates to a whole host of other factors that determine how quickly and easily development-stage projects can advance to production or exploration-stage projects can advance to development.
TGR: Do you expect more mergers and acquisitions (M&A) in the silver space, perhaps based on this garage sale effect that's going on right now in the equities space? What market factors prompted that conclusion? Is that conclusion unique to the silver space among precious metals?
CT: We have to look at the industry from two points of view. First, we have to look at it from an acquirer's perspective. What companies are positioned to purchase assets? What companies are looking to grow their production profiles through making acquisitions? Second, you have to look for prospective acquisition targets. What companies have good-quality assets that are suffering in today's market because of lack of funding and weak investment sentiment for development- and exploration-focused stories?
What we find in the silver sector is that despite the current soft silver price, operating margins that a lot of silver producers are enjoying are some of the best in the sector. The average industry cash costs for silver producers are less than $10/oz, which implies a healthy operating margin at a silver price of ~$30/oz. A lot of silver producers are generating significant cash flow in this environment.
Realizing that investor sentiment in the mining sector is weak, a lot of companies that are trying to advance exploration projects or development-stage projects are battling to finance the advancement of their development and exploration plans. You coined it—it is pretty much a garage sale out there for exploration and development stories. The acquirers have healthy treasuries and the ability to generate additional cash flow to support larger treasuries and the targets are being starved of funds to develop their project—it's a buyer’s market.
TGR: What approach to silver equities, especially those in the exploration and development phases, will best serve the average retail investor?
CT: Looking at silver equities is no different from looking at equities focused on developing, advancing and exploring for other metals. One of the most important attributes of any company is management. You need a good team that can deliver efficiencies in what is a relatively challenging time for mining based on a lot of cost creep and margin squeeze. It's all about the team. In silver we look for quality over quantity. Look at the ounces in the ground that will work from an operating perspective rather than just the size of the inventory.
TGR: High grade, too?
CT: Grade, good metallurgy, safe jurisdiction. As I've said before, people throw out silver projects in many senses as offering size potential, but there is no value in having hundreds of million ounces silver in situ in the ground if you can't mine them profitably. Also, be wary and recognize that silver is arguably the most volatile of all precious metals and equities, by extension, are also volatile.
TGR: Thanks for your time and insight.
Chris Thompson was trained in South Africa and has over 20 years of industry experience working as a geologist for major through to junior mining/exploration companies, in addition to a stint working as a mineral economist for the South African state. He has a bachelor's degree from the University of the Witwatersrand, a graduate degree in engineering, a master's in mineral economics and a PGeo designation. Thompson has been with Haywood Securities for over six years and specializes in junior exploration and the silver and PGM sectors. Thompson was recently awarded the 2011 StarMine No. 1 Stock Picker award for the Canadian metals and mining sector.
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